ANNUAL REPORT 04/05

TO LEAD IN DAIRY

TO LEAD IN DAIRY – FONTERRA ANNUAL REPORT 04/05 PATHS TOLEADINDAIRY

Insight Creative Limited. Auckland. 09/05 FOOP001 OUR VISION AT FONTERRA IS CLEAR – TO LEAD IN DAIRY.

WE ARE EQUALLY CLEAR ABOUT OUR SEVEN PATHS TO LEADERSHIP:

1 Ensuring when anyone thinks dairy they think Fonterra

2 Putting the customer first

3 Making dairy an integral part of people’s nutrition everywhere

4 Delivering an integrated cow to customer value chain

5 Making Fonterra’s Brands first choice

6 Employing and motivating talented people around the world

7 Winning and retaining the loyalty of shareholders

THIS YEAR’S REPORT CELEBRATES PROGRESS TOWARDS OUR VISION.

01 | 2005 ANNUAL REPORT

CONTENTS 2004 / 05 Season Review 02 Operational Review 28 Board of Directors 39 Chairman / CEO Review 04 Performance Measures 34 Fonterra Leadership Team 42 Seven Paths to Lead in Dairy 13 Corporate Governance 36 Financial Statements 45 2004/05 SEASON IN REVIEW

2004/05 2003/04 2002/03 2001/02*

SHAREHOLDER RETURNS Payout (NZD per KG/MS) 4.59 4.25 3.63 5.33 Historical Commodity Milk Price 4.37 3.97 3.34 5.45 Milk Price Gap (0.23) (0.20) (0.18) *** (0.39)

Fonterra Commodity Milk Price 4.14 3.77 3.16 5.06 Value Add Contribution to Payout ** 0.45 0.48 0.47 *** 0.22

Fair Value Share Price (NZD) set for the next season 5.44 4.69 4.38 **** 3.85

Total Shareholder Return 17.2% 11.0% 16.7% n/a Total Shareholder Return, excluding FX hedging relating to next season’s payout 19.4% 11.1% 14.1% n/a Total number of shareholders (supply numbers) at 31 May 11,680 12,144 12,562 13,057

MILK STATISTICS Total NZ milk collected (Million Litres) 13,503 14,016 13,429 13,133 Highest daily volume collected (Million Litres) 68.5 70.2 67.6 66.1

NZ Milksolids collected (Million KGs) 1,160 1,201 1,148 1,111 Average Milksolids supplied per supply number (000’s KG/MS) 99 99 91 85

Dairy Ingredients manufactured in New Zealand (000’s MT) 1,952 2,042 1,940 1,746 Total Ingredients Sales Volume (000’s MT) 2,413 2,442 2,335 1,850

STAFF EMPLOYED 02

| Total Staff Employed (000’s) 18.6 19.6 19.8 20.0 New Zealand (000’s) 11.6 11.1 10.8 n/a Overseas (000’s) 7.0 8.5 9.0 n/a 2005 ANNUAL REPORT 2004/05 2003/04 2002/03 2001/02*

OPERATING PERFORMANCE Average Commodity Prices (USD per MT FOB) Whole Milk Powder 2,180 1,805 1,522 1,743 Skim Milk Powder 2,163 1,797 1,496 1,760 Butter 2,015 1,496 1,134 1,222 Cheese 2,763 2,170 1,675 2,070

Source: Oceania Export Series, Agricultural Marketing Service, US Department of Agriculture

Average USD/NZD Spot Exchange Rate applying throughout the year ***** 0.69 0.62 0.51 0.43 Fonterra’s average USD/NZD conversion rate ***** 0.61 0.52 0.48 0.44

Revenue (NZD millions) Ingredients and other revenue from outside of the Group 8,548 8,194 7,887 8,341 Consumer revenue from outside of the Group 3,775 3,636 4,587 5,583 Total Revenue 12,323 11,830 12,474 13,924

Segment operating result excluding non-recurring items (NZD millions) ****** Ingredients ******* 601 563 407 n/a Consumer Brands 265 280 404 n/a Inter-Group Eliminations ******* (43) (4) 6 n/a Segment operating result excluding non-recurring items 823 839 817 599

Net Surplus/(Deficit) after minorities (NZD millions) 191 7 257 (50)

03 CAPITAL EMPLOYED | Total Assets Employed (NZD millions) 11,812 11,112 10,746 11,800 Shareholders’ Funds, including minority interests (NZD millions) 4,911 4,795 4,665 4,485 Net Interest Bearing Debt (NZD millions) 4,344 4,041 4,388 4,718

Debt to debt plus equity ratio 46.9% 45.7% 48.5% 51.3% 2005 ANNUAL REPORT

* Certain comparative information for the 2001/02 season is not available due to the structure of the Group’s reporting systems. ** The Value Add Contribution to Payout is a measure of the value added (including the cost of capital) to suppliers’ milk by Fonterra from all of its operations, over and above the value of milk supplied. *** Applying different methodology to that used in 2002/03, 2003/04 and 2004/05. **** Initial Fair Value Share price was a nominal value set by the Fonterra Board; subsequent valuations determined from within the range set by the independent valuer. ***** Average exchange rate is the average of the daily spot rates for the season. The average conversion rate is the rate that Fonterra has converted net foreign currency receipts into NZ Dollars based on the hedge cover in place. ****** Represents earnings before interest and tax calculated on the basis of the historical CMP and adjusted for non recurring items. ******* The revaluation of investments to net asset backing made in the parent entity, and the elimination of this adjustment were previously included in the Fonterra Ingredients operating surplus and eliminations respectively, these have now been excluded. The prior years have been restated to be on a consistent basis. CHAIRMAN / CEO REVIEW

Our Vision, To Lead in Dairy, makes it clear we intend to be best in class. Our performance this year shows excellent progress, reflecting the results of business strategies directly linked to consumer and customer needs and the competitive advantages we have to offer.

The final payout for the 04/05 season was $4.59 per kilogram of milk solids, a nine cent increase on the final forecast payout for the season and 34 cents up on the prior season. The payout, which is the second highest since the co-operative’s inception, reflects strong performance by the business in spite of a high exchange rate. The season finished on a positive note, despite a difficult year for farmers with a cold wet start and a long hot summer, both of which hit milk production.

In addition to increasing payout for shareholders the value of their long-term investment in the co-operative, as measured by the Fair Value Share, also increased from $4.69 in the 04/05 season to $5.44 for 05/06.

04 Total Shareholder Return (TSR) | for the season was 17.2 per cent. This compares with the annual compound average TSR for the last three years of 14.1 per cent, and 11.0 per cent for last year. 2005 ANNUAL REPORT

HENRY VAN DER HEYDEN ANDREW FERRIER

CHAIRMAN CHIEF EXECUTIVE OFFICER Financial Review

Group Financial Performance – Year Ended 31 May

2004/05 2003/04 $ Millions $ Millions

Total revenue 12,323 11,830 Fonterra Commodity Milk Price 4,804 4,528 Value add milk returns 525 576 Total cost of milk at final payout (5,329) (5,104) Other costs of goods sold (4,833) (4,655) Total cost of goods sold (10,162) (9,759) Gross margin 2,161 2,071 Operating expenses (1,648) (1,779) Interest expense (269) (250) Surplus before taxation 244 42 Taxation expense (25) (26) Surplus after taxation 219 16 Minority interests 28 9 Net surplus after minorities 191 7

Revenue revenues, however the negative Fonterra Brands had a positive result Total revenue for the season increased impact of this was more than offset overall with revenue increasing by by $493 million to $12.3 billion. This by higher prices and gains from 3.8 per cent. However excluding increase includes one off gains on the Fonterra’s hedging policy. the impact of divestments revenue sale of investments including NZ Milk decreased by 2 per cent primarily 05

Fonterra Ingredients’ good result was | Mexico and Fonterra’s National Foods due to the strengthening of the achieved even though New Zealand New Zealand dollar. stake. Excluding one-off gains from milk supply was down by 3.5 per cent divestments, operating revenue at 1,160 million kilograms of milk increased by $250 million. solids as a result of difficult weather Commodity Prices The major contributors to revenue conditions. The increase in sales of Average commodity prices firmed by were Fonterra Ingredients’ revenue of product produced by third parties approximately 20 per cent per MT 2005 ANNUAL REPORT $8.6 billion (excluding intersegment helped offset the domestic production during the season, contributing to sales to Fonterra Brands of $1.4 shortfall. Fonterra Ingredients increased revenue. This increase, billion) and Fonterra Brands with total achieved total sales volumes of while positive for Fonterra overall, revenue of $3.8 billion (excluding 2.4 million MT in line with last negatively impacted the segment intersegment sales of $59 million). season’s performance. This outcome operating results of Fonterra Brands shows the effectiveness of the third and Fonterra Specialty Products Fonterra Ingredients’ revenue party sourcing strategy, which ensures businesses as these businesses had to reflected higher commodity prices customers needs are consistently bear higher costs, which had an with underlying USD sales 20 per cent met with reliable secure supply adverse effect on value add. above those achieved in 2004. The with New Zealand production strengthening of the New Zealand complemented by product sourced dollar significantly reduced NZD from other countries. CHAIRMAN / CEO REVIEW – Continued

This along with the impact of foreign $5.3 billion compared to $5.1 billion prices and in the value of inventory earnings being converted at a higher last season. It comprises the Fonterra required in the carryover period New Zealand dollar meant that value Commodity Milk Price (“FCMP”) of following the year-end. add was down $51 million on the $4.14 per kilogram of milk solids and We continue to have a strong balance prior year. a value-add contribution of 45 cents. sheet with a debt to debt plus equity This compares with a FCMP of ratio of 46.9 per cent. This was $3.77 last season and value-add Cost of Goods Sold further enhanced by the receipt of contribution of 48 cents. Total cost of goods sold rose by $403 the National Foods’ proceeds after million to $10.2 billion, mainly as a balance date of AUD 361 million. result of the higher commodity milk Retention price and the additional costs related As a co-operative, Fonterra distributes OPERATING RESULTS BY SEGMENT to increased sales of third party its surplus to shareholders by way of product. Fonterra Brands’ cost of payout which this year amounts to a Fonterra Ingredients goods sold declined by $66 million, total distribution of $5.3 billion. Operating Results partially reflecting the sale of New Fonterra recorded a net surplus for Fonterra Ingredients’ revenue Zealand Milk Mexico during the year. the year of $191 million, primarily as increased as a result of the a result of profits from divestments. significantly higher commodity prices Operating Expenses The Board decided to retain these prevailing during the season, offset by profits in the business. Fonterra’s total operating expenses the higher currency. Despite the fell by $131 million to $1.7 billion, shortfall in New Zealand supply, the reflecting lower offshore operating Cash flow business demonstrated its ability to maintain sales volumes, and meet costs primarily in Fonterra Brands as a Net interest bearing debt has customer commitments, through its result of the stronger New Zealand increased in the current year by $303 third party sourcing strategy. dollar. The reduction also reflects tight million. This was necessary to fund cost controls as the business higher working capital requirements Fonterra Ingredients’ Segment refocused its spend around its key as a consequence of the record high Operating Result excluding non- brands and made savings after the commodity prices, which increased recurring items was $601 million for the sale of the Mexico business. Fonterra the value of inventory carried season. Including non-recurring items of Ingredients’ operating expenses are throughout the year. This was partially $13 million, which relate to the gain on consistent with the prior year. offset by an increase in the amount the sale of our Wrightson investment, owing to suppliers. the result was $614 million.

Payout Operating cash flows have fallen this This was a solid achievement given Fonterra’s payout of $4.59 per year as cash paid to suppliers the very high underlying commodity kilogram of milk solids represents a increased $559 million due to the prices which negatively impacted the total distribution to shareholders of significant increase in commodity Segment Operating Result.

Fonterra Ingredients* Segment Operating Result (SOR) – Year ended 31 May

2004/05 2003/04 $ Millions $ Millions

06 Sales to customers outside group 8,548 8,194 | Inter-segment sales 1,377 1,346

Total revenue 9,925 9,540 Cost of milk (Fonterra CMP) (4,804) (4,528) Other costs of goods sold (3,682) (3,543)

2005 ANNUAL REPORT Gross margin 1,439 1,469 Operating expenses (825) (823) Segment operating result*** 614 646 Non-recurring items** 13 83 SOR excluding non-recurring 601 563

* Fonterra Ingredients segment includes the business that comprised Fonterra Ingredients, as well as Fonterra Enterprises and Corporate costs. ** Non recurring items in 04/05 relate to the gain on sale of investments. In 03/04 these related to the reinstatement of brand impairment and other. *** The revaluation of investments to net asset backing made in the parent entity was previously included in the Fonterra Ingredients operating surplus. This has now been excluded and the prior year restated to be on a consistent basis. Fonterra Brands Segment Operating Result (‘SOR’) – Year ended 31 May

2004/05 2003/04 $ Millions $ Millions

Sales to customers outside group 3,775 3,636 Inter-segment sales 59 132

Total revenue 3,834 3,768 Costs of goods sold (2,544) (2,610) Gross margin 1,290 1,158 Operating expenses** (832) (943) Segment operating result 458 215 Non-recurring items* 193 (65) SOR excluding non recurring 265 280

* Non recurring items in 04/05 relate to the gain on sale of investments, brand (impairment) / reinstatements and other. In 03/04 these related to net impairment of Brands. ** Fonterra Brands prior year operating expenses have been restated to include an allocation of corporate costs to be on a consistent basis with the current year.

Fonterra Brands Operating Results want foods to guard against specific • Fonterra Ingredients focused on Fonterra Brands’ Segment Operating illnesses. Others want pure indulgence. core ingredients products and our Result including non-recurring items customers. Its focus is building Dairy meets all these needs. Our strong alliances with our key global was $458 million compared to $215 returns to shareholders are influenced million in the prior year. Excluding customers and ensuring we deliver by how well we enable food the right products and services to non-recurring items of $193 million, manufacturers, retailers, the primarily relating to the gain on the our customers, at the right price to foodservice industry and consumers them and the right cost to us. sale of investments, the Segment to make that connection and more Operating Result was $265 million importantly, buy our ingredients and • Fonterra Brands, our consumer compared to $280 million last season. branded dairy products. Our strategy branded dairy products business. It Fonterra Brands’ result represents is designed to grow these returns is implementing new strategies to good progress in a difficult year with through strengthening our positions raise our value-add earnings from the business meeting its earning our highest value brands in our targets despite the real challenges of major markets. record high commodity prices and the Our structure • Fonterra Foodservices, designed to strength of the New Zealand dollar supports our strategy which had an adverse impact on the meet the very specialised demands Segment Operating Result relative to of customers in this high-growth the prior year. The result was achieved TO LEAD sector who want branded dairy as the business developed its Winning goods as well as core ingredients and ready-to-use products. This 07

Through Brands strategy to lift the | performance of its top earning IN DAIRY. sector includes fast food outlets, brands, increase innovation, grow its cafes, bakeries and caterers. foodservices business and achieve in the commodities, specialty • Fonterra Specialty Products, which supply chain efficiencies in the develops, manufactures and coming years. products, foodservice and branded dairy products market, defending our markets high-value specialist Season Review low cost position, building valuable ingredients to our global 2005 ANNUAL REPORT customer partnerships and increasing customers. Creating specialty Wherever they are in the world, our rate of innovation. products as a distinct business unit consumers shape demand in the food enables more performance industry. What they want today and To Lead in Dairy, it is critical our transparency and more focus on what they might want tomorrow structure supports this strategy. We truly value-added activities. occupies the minds of manufacturers, now have our structure closely retailers and the hospitality sector. aligned to our different customer Each of these businesses is supported groups and their specific needs and to by strengthened innovation and Consumers’ needs are diverse. Some the consumer market. We have four manufacturing platforms, the want good, cheap nutrition. Others individual businesses: business leaders of which have joined want fast, convenient food. Some the Fonterra Leadership Team, CHAIRMAN / CEO REVIEW – Continued

recognising the importance of these global customers and is designed to cow can be delivered in New Zealand, functions to Fonterra and to our ensure that strict customer we cannot afford to be complacent. customer relationships. confidentiality, so important to all our relationships, is maintained at the That’s why Fonterra has developed Fonterra Group Manufacturing is a highest levels. Our structure will its Foundation Strategy Theme: function designed to ensure global strengthen our focus on ensuring we A Sustainable Co-operative. best practice across our group deliver the right products and services That means continuing to drive and manufacturing and supply chain to our customers at the right price to pursue that growth to sustain our functions. It is organised to ensure them and cost to us. In short, world-leading position and to sustain maximum efficiencies are achieved structure supports strategy. our co-operative by continuing to right across these functions, grow both payout and farmers’ everywhere in the world. Growing Supply to Meet investment in their co-operative. Fonterra Innovation, which replaced Customer Demand But we also recognise that growth Marketing and Innovation, is Global demand for dairy is increasing can’t come at any cost and there is a organised to enable us to make the by two per cent a year and this real emphasis on achieving our goals through our farmers following sustainable practices. If they grow, we grow and so does our important a key part economic contribution to SUSTAINABILITY of strategy. New Zealand. The sustainable co-operative foundation theme recognises that there is more we can do to work with most of our research and growth will drive our own so long as our farmers to grow supply. development capabilities and our our milk supply increases. Fonterra knowledge of the functional and can and does source dairy products There is also more work to do in nutritional qualities of milk and from international supply partners to ensuring the New Zealand public leverage these strengths across all meet customer demand and offset understands this growth will be our businesses. supply risks for them. managed through practices that will sustain the environment in which we It is charged with maximising our But as a co-operative, owned by New also live and work. innovation potential for our Zealand farmers, our preference will customers, including always be for their farms to be our Agriculture as a whole faces Fonterra Brands. first source of supply so we continue competition for land from urban to grow wealth for shareholders. growth and conversion of This new structure enables greater agricultural land to urban land is focus on our different customer and At the core of Fonterra’s strength is largely irreversible. consumer groups, improved ability to the ability of our farmers to maintain manage and measure performance in low-cost production structures while

08 | 2005 ANNUAL REPORT

each business, more efficient and continuing to grow milk supply by an We also need to be thinking now targeted use of financial and human average three per cent year-on-year. about tackling any disincentives to resources, more accountability and It’s a competitive strength for us, but growing supply, such as competition greater efficiencies. not one we can take for granted as for water resources, rising energy and emerging producers around the word labour costs and the risk that The structure supports our ability to take on our leading position. While environmental policies affecting build strong alliances with our key higher production per hectare and per farming may be influenced more by sentiment than science. Just as importantly, we need to ensure that dairy, through continually FONTERRA CO-OPERATIVE GROUP improved returns, remains the preferred use of agricultural land in CUSTOMERS New Zealand.

This work will be a priority in the coming year and will complement what we do already to promote milk growth. FONTERRA FONTERRA FONTERRA FONTERRA We have already made important INGREDIENTS SPECIALTY FOODSERVICES BRANDS progress in tackling issues which PRODUCTS influence sustainability by undertaking a capital structure review during the year.

Extensive consultation with our PEOPLE shareholders identified that aspects of FONTERRA GROUP MANUFACTURING our capital structure were potential SHAREHOLDERS barriers to the milk growth that will support our future. FONTERRA INNOVATION

Our shareholders told us a high Fair Value Share was a potential barrier to FONTERRA MILK SUPPLY growth or expansion as they did not wish to invest the additional capital in FONTERRA SHARED SERVICES shares to match their growth. (Human Resources, Communications, Strategy, Finance)

The complexities of a Peak Notes system to manage peak production demands on the co-operative, were also a perceived further disincentive An important change, which directly Strengthening our to growth. Using Supply Redemption supports milk growth, allows Fonterra Competitive Advantages Rights to manage undersupply in any to source a maximum of 15 per cent We are the lowest cost producer of one season was a further complexity of milk in any one season under dairy commodities at scale and we in our structure. contract. Farmers entering these have an efficient supply chain able to contracts won’t need to hold shares reach customers in more than 140 In one of the highest voter turnouts to back that supply. countries from a home base in the in recent co-operative history, southernmost part of the world. Fonterra shareholders overwhelmingly Contracting will therefore allow supported our capital structure existing farmers room for growth revisions that led to a single capital without having to pay capital for

09 | 2005 ANNUAL REPORT

instrument, Fair Value Share, the additional shares, may assist in These, coupled with our research and scrapping of Peak Notes in favour of a reducing redemptions and provide development capabilities, our pricing signal for peak production and an alternate route for entry into the extensive knowledge of milk’s the replacement of Supply co-operative for new and functional and nutritional qualities Redemption Rights with provisions for younger farmers. and our dairy manufacturing Excess and Unshared Supply to expertise, give us competitive manage one-off seasonal variations advantages that we are building on in production. To Lead in Dairy. CHAIRMAN / CEO REVIEW – Continued

This season, we have defended our of Fonterra Innovation as their cost position vigorously, achieving research and development arm, our higher planning efficiencies, a better manufacturing sites as their product mix matched to demand and manufacturing sites, our supply chain reductions in product specifications so as their supply chain. The completion we get even more efficient runs in 40+ of this programme sees us move our sites. PROJECTS significantly closer to that goal. Projects have been initiated to reduce the cost of getting milk from farms to Investing for Growth factories and factories to ports. One world-class Last season we advised shareholders supply chain. to expect strategic investments that Our supply chain is now up to world- would enable us to grow the business class standards as we come to the final faster than the organic growth rates stages of the most far-reaching change between global markets as we use we have been achieving. programme ever undertaken by the our third party supply strategy to business. The JEDI programme has Our takeover bid for National Foods satisfy customer demand for secure, involved hundreds of Fonterra staff was a case in point and illustrates two reliable supply. and staff from partner companies, principles. First, that any investment who have worked for over three years Products sourced from countries will target clear growth opportunities to implement over 40 projects which including South America, USA and and second, it must represent value have touched every corner of Fonterra. Australia now complement New for money. National Foods measured Zealand product, with our efficient up on the first count, as a successful The programme has brought an SAP supply chain a factor in achieving bid, which valued the business at system and business processes into consistent margins on these sales. $1.9 billion, would have taken us into Fonterra Ingredients, creating a the national milk and yoghurt market shared IT system, and common ways We are now able to service all our in Australia, complementing our of doing business, from demand different customer groups at the best leadership position in cheese and forecasting, product planning and price for them and the lowest cost for spreads. However counterbidding by manufacturing right through to our us, but this change is about far more San Miguel, raised the price to levels regional sales offices and customers than getting products to customers which we believed did not represent around the world. It will be on time, in full and in specification. the best value for money for completed in September 2005. shareholders and the decision was Having a simple, reliable and efficient taken in April to divest our 19 per Fonterra’s major business challenge is supply chain enables us to give our cent shareholding for AUD 361 to keep the market for dairy growing full attention to our relationships with million. This produced a gain of $195 by developing our relationship with our customers as we guarantee them million in addition to the dividend our customers. Put simply, if security of supply. income of $45.5 million received Fonterra’s business with our during the life of the investment, first customers is not growing, then the It opens the door to strengthening made in 2000. co-operative will not grow. and deepening our relationship with

10 | 2005 ANNUAL REPORT

The programme was all about making them, becoming their partner of The decision to divest was in line with sure Fonterra Ingredients delivers the choice and integrating into their our disciplined investment parameters right level of service to customers. In supply chain. This means being a total around growth potential and value to addition to getting New Zealand partner to these companies, growing shareholders which were also applied products efficiently to world markets, our business by helping them develop to other investments during the year. our supply chain is an increasingly and grow their businesses. Our ideal These include the divestment of our valuable way to move product is to have our major customers think Wrightson stake and the sale of New Zealand Milk (Mexico). We remain very focused on growth, CFI will deliver customers a broader That is why Fonterra is a strenuous with our Mergers and Acquisition product range with greater security of advocate for trade liberalisation and will team charged with identifying and supply and an enhanced product always support every effort by the New evaluating opportunities in New development capability. The Zealand government to advance this Zealand and internationally. In integration of Fonterra and Clover’s cause. It is important to acknowledge Australia where we have a strong manufacturing and supply chain the excellent progress made by the commitment to the industry and its processes will play a big part in government during the year. success, this saw the move, post achieving this. balance date, to be part of the New Zealand’s Closer Economic rationalisation of the industry through Similarly, our sales agreement with Partnership agreement with Thailand, a combination of changes and Argentina’s SanCor Co-operativas for example, represents an acquisitions. These streamline our Unidas Limitada, through which we opportunity for improved access to a Australasian home base, reduce costs, will market and distribute SanCor’s growing market while the opening of enable greater efficiencies and free trade negotiations with members strengthen our milk collection and of the Association of South East Asian processing capabilities. Nations (ASEAN) and Australia is a further welcome step forward. ASEAN These moves include: GROWTH consumes more than 25 per cent of • acquisition of the remaining 50 all dairy products exported from per cent of Bonlac Foods Ltd (BFL), opportunities New Zealand and having a free trade which includes purchase of the agreement in place could reduce the Murrumbidgee Dairy Products remain a priority tariff burden and remove the element (MDP), the liquid milk, desserts of uncertainty around duty rates that and yoghurt company based in New Zealand and Australian exporters Wagga Wagga currently face. bulk commodity ingredients outside • an agreement to purchase Nestlé’s Argentina, is a partnership which We are greatly encouraged at the powdered milk plant at Dennington enables us to grow supply to our progress made by the New Zealand in Victoria, including handling milk major customers, makes full use of government towards a free trade collection for that operation which our global marketing strengths and agreement with China, another supplies to Nestlé in Australia benefits all parties. important market for dairy. We are • consolidation of our consumer keen to see China’s tariff rates reduced to zero as soon as possible, businesses under the Fonterra Free Trade Progress Brands umbrella. and for investment protection New Zealand is now the leading provisions to be put in place. A further growth development was supplier to the global trade in dairy our May 2005 joint venture products and Fonterra makes a Also encouraging is the establishment agreement with South African dairy significant contribution to this of a Joint Experts Group (JEG) between company, Clover Industries Ltd to position. However, it is important to Mexico and New Zealand aimed at form Clover Fonterra Ingredients (CFI) recognise that only seven per cent of strengthening economic relations.

11 | 2005 ANNUAL REPORT

which will handle the marketing of total global milk production crosses The hope is that a New bulk dairy ingredients, carry out international borders. A three per Zealand/Mexico Free Trade Agreement contract ingredient manufacturing, cent increase would exceed Fonterra’s (FTA) negotiation will ultimately result and supply food service products to current worldwide sales. from this process. The role of the JEG nominated quick-service restaurants will be to identify issues and discuss throughout the sub-Saharan region. CHAIRMAN / CEO REVIEW – Continued

areas for improvement and solution. As we come into the critical was further strengthened during the cooperation to further promote stage of the Doha Round, we are year with the addition of Bob Major, economic relations between the concerned that the main parties now Director Innovation and Max two countries. remain too far apart particularly on Parkin, acting as Director Group the key issue of agricultural market Manufacturing. John Shaskey has Mexico rates highly on Fonterra’s list of access. A lot of work will need to be assumed the role of Managing priority countries for an FTA. It is the done over the second half of 2005 to Director Fonterra Ingredients. We world’s fourth largest dairy importer keep this key element of the Doha thank our former Chief Operating and Fonterra’s seventh largest market Round on track. Officer, Jay Waldvogel, for his for New Zealand origin exports. considerable commitment to the We remain excited at the prospect co-operative and the industry. We also congratulate the government that export subsidies will be The strength of Fonterra Ingredients on achieving the first multi-party free eliminated, but there is no consensus is testimony to his contribution. trade agreement spanning the Pacific yet on the end date or length of the and Asia. The Trans-Pacific Strategic phase out period. With so much still Our results reflect the efforts of our Economic Partnership, due to be to be done, Fonterra, as part of the people as well as the support of our implemented in January 2006, will Dairy Companies Association of customers and consumers. We jointly link New Zealand with Chile, New Zealand, has been pleased to thank our suppliers, employees, Singapore and Brunei, liberalising work with other members of the management team, Directors and the trade in goods and services between Global Dairy Alliance of dairy export customers and consumers who have the four countries. industries in Oceania and Latin all contributed to our performance America to push for dairy It is hoped that the coming year will this year. trade liberalisation. see renewed progress towards the launch of negotiations for a FTA between New Zealand and the United Acknowledgements States. New Zealand faces real time To Lead in Dairy requires operational pressure to be added to the USA’s list excellence across our entire business of prospective FTA partners. If and a real commitment to improving negotiations are not completed our performance every year. before President Bush’s Trade HENRY VAN DER HEYDEN Promotion Authority expires in June We welcome Sanjay Khosla, CHAIRMAN 2007, we are likely to face a delay of Managing Director Fonterra Brands, some years before a President Guy Cowan, Chief Financial Officer achieves a new mandate for trade and Barry Harris, Director Fonterra negotiations from the Congress. Milk Supply to Fonterra. They have made an immediate contribution to While we will always support efforts the business and the Fonterra towards Free Trade Agreements, Leadership Team. As a result of the Fonterra remains fully committed to new organisational structure ANDREW FERRIER multilateral trade as the first and best discussed in this report, that team CHIEF EXECUTIVE OFFICER

12 | 2005 ANNUAL REPORT SEVEN PATHS TO LEAD IN DAIRY

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N O L W D P L O O M E R C O P E R T D E IV TE D LIV ATE TALEN L DE O H E R A H W P S IN AND KEE

FONTERRA’S VISION IS TO LEAD IN DAIRY.

Leadership is easy to aspire to, but difficult to achieve without everyone in the business having a clear understanding of 13 what leadership really means and the actions that need to be taken to achieve it. Only then can we earn recognition as | leaders in dairy from our customers, consumers, shareholders and our employees.

In the following pages, we discuss the seven paths we are taking To Lead in Dairy and feature some of the people who have contributed to our progress towards that goal this year.

They, along with countless others not profiled, have made a real commitment to building strong customer relationships, 2005 ANNUAL REPORT winning consumer confidence and earning the loyalty of our shareholders through our performance. ENSURING WHEN ANYONE THINKS DAIRY

SEVEN PATHS TO SEVEN PATHS LEAD IN DAIRY 1 THEY THINK FONTERRA

Ask the Experts specifications which included When one of our customers formulations using a high wanted a number of dairy milk powder content and standard equipment. dessert formulations, easily combined into consumer The formulation uses a “one pot” products with little technical process, saving manufacturers’ expertise, they thought operational costs and enabling “Fonterra” and we thought significant savings in capital. As an “John Smith”. ingredient the formulation has a 12 month shelf life and when used in The challenge involved dulce de consumer products, it has a six month leche, a traditional and much loved shelf life without refrigeration. Better Latin American milk-based sweet. still, it has a true milk caramel Home cooks take several patient flavour, colour and consistency hours to make a batch. Large that our customers and consumers scale manufacturers usually take want. It’s also a winning formula – two to five hours. John and his picking up the New Zealand Trade team, in Fonterra Innovation and Enterprise Export Award at beat them both hands down Massey University’s National with a 65 minute solution. It Food Awards, as well as the PCI responds to the customer’s Packaging Industrial Products Award.

MINUTE 65 SOLUTION JOHN SMITH 14 | Business Manager, Formulated Milks. 2005 ANNUAL REPORT Fonterra has demonstrated that we are the experts in dairy. Fonterra is the leader in dairy production. We source the bulk of our milk from the world’s most efficient dairy farmers, harvesting the natural goodness of New Zealand’s world renowned clean, green pastures. Fonterra’s people are dairy people, using our knowledge of milk production, science, technology and marketing to connect the world’s best quality milk and branded dairy products with consumers globally.

Giving Consumers Confidence > protected against the development A new slice on slice cheese of moderate anaemia, 87 per cent agreement with McDonald’s Parents thinking about child health better protected against the will significantly increase our can confidently choose our development of severe anaemia supply, and consumer products. and six per cent less likely to includes That’s because Joanne Todd, need antibiotics. supply to Fonterra Brands Health Platform Australia Children consuming the milk powder Manager, can back the benefits of for the first fortified with the prebiotics and fortified milk with proven science, time – an probiotic DR10™ were 21 per cent after Fonterra Brands set the achievement better protected against dysentery, benchmark with the world’s first large that bodes well 32 per cent better protected against scale clinical trial on fortified milks. for future growth. sickness with high temperature, seven The one year trial by researchers from per cent better protected against ear infection, 16 per cent better OUR Johns Hopkins University School of MOZZARELLA Public Health, involved 1,272 one-to- protected against severe illness, TOPS PIZZA IN four year olds, two test Fernleaf 1+ and six per cent less likely to 32 32 COUNTRIES fortified formulations and two control need antibiotics. ROB COLLIER formulations. These products included prebiotics, the probiotic DR10™; and One Company, Many Products > Global Account Manager, Nutri-care™, a special combination of Fonterra Foodservices. Convenience is one of the big driving vitamins and minerals including forces in consumer eating habits vitamins A, C, E and minerals iron, The new business involved and it’s fuelling growth in zinc, and selenium. working closely with our Foodservices. It’s also a big manufacturing and in market consideration for the chains The results showed that children operating companies and leveraging meeting consumer needs for consuming Fernleaf 1+ Nutri- Fonterra’s global reach and local fast, tasty food. Rather care™ formulations were presence. As a result we now supply than deal with multiple 19 per cent better slice on slice cheese to McDonald’s in dairy suppliers, they protected against 19 countries. diarrhoea, 26 per prefer partners cent better who can supply We also supply mozzarella to Pizza protected against everything they Hut in 32 countries and thanks to need and have the Rob and his team our shredded acute lower 15 respiratory infections, capability to engage parmesan is on the menu in a | and 28 per cent better in product number of markets. Meanwhile, protected against severe development programmes. shredded cheddar is being used in respiratory infections. They Middle Eastern markets for the first Enter Rob Collier, Global were also 79 per cent better time as an ingredient in KFC’s cheese Accounts Manager for toasted snacks. Fonterra Foodservices. He has grown our global Our ability to supply is matched by 2005 ANNUAL REPORT business, exceeding our expertise, illustrated by a new FIRST 04/05 budget targets for product development programme 1,272 McDonald’s and Yum! with Yum! and McDonald’s, which CHILDREN TRIAL (KFC and Pizza Hut) by covers a range of dairy, beverage, presenting Fonterra as one snacking and dessert developments. JOANNE TODD company with wide ranging Fonterra Brands Health capabilities and products from Platform Manager. specialty cheeses to luxury ice creams. PUTTING THE CUSTOMER FIRST

SEVEN PATHS TO SEVEN PATHS LEAD IN DAIRY 2

Superior Supply Chain with benefits, including supply Being the world’s largest dairy security and higher on-time, in-full ingredients marketer does not and in-specification performance, as early adopters among our customers earn us customers as of right. have found. The new operating Size counts for nothing if we model provides a solid platform on cannot deliver our customers which we can build an expanded the products that they want range of customer offerings and a on time, in full and to their world class supply chain. specification, regardless of where they are in the world. In addition to enabling better demand/supply matching, our new That’s why we put significant way of working is designed to free up financial and human resources our sales people to spend more into an intensive three-year quality time with customers, programme to re-build our determining how we can help them operating model to directly link more and less time spent on sales our customers’ demand to an administration. That change is integrated logistics function important as we work towards our and our supply capabilities. goal to be the leading developer of valuable customer relationships. During the year, our SAP-based system has been rolled out, introducing common business processes, from demand forecasting back into production planning, through logistics to order fulfilment. For people like Peter Landon-Lane, General Manager of Cheese and Protein in Sales and Operations Planning, that’s required intensive work, helping our Network, our customers and our Supply Chain to 16 adapt to the new systems and

| business processes. The effort comes 2005 ANNUAL REPORT

S&OP

PETER LANDON-LANE General Manager, Cheese and Protein By focusing on customers and consumers, Fonterra will lead in anticipating and understanding customer and consumer needs, and in building lasting customer relationships. Fonterra people will work with our customers to set realistic customer service expectations and then set out to exceed these expectations. We will deliver a great experience based on the understanding that our frontline people are there to address our customers’ needs and concerns.

Making PharmaLactose The first Inhalation Grade Lactose was This is its first year of First Choice > processed at the $25 million Kapuni operation, with the FCSC The ability of Carey Lee and her plant in March, just 13 months after taking its first team to put the customer first has construction commenced, with the regional made Fonterra’s PharmaLactose project meeting Good Manufacturing customer specialty products business a Practice (GMP) and Manufacturing calls in preferred supplier to one of the Excellence (ME) assessments. October world’s leading pharmaceutical 2004 and companies, a world leader in Fonterra Customer becoming fully respiratory pharmaceuticals. Service Centre > global by June 2005. It is early Around the clock and around the Six years of planning, three of them days, but the Centre’s world the New Zealand-based with our customer, meant that when call statistics since our new production facilities at Fonterra Customer Service Centre Kapuni opened in May 2005, they (FCSC) under the leadership of were aligned to their detailed Matthew Foster supports our 24/7 User Requirement Specifications customers and our ingredients sales SERVICE as well as US Food and Drug network by managing order Administration regulations. processing and inquiries. MATTHEW FOSTER

The agreement to supply half of this More than 100 Customer Service General Manager, Representatives work in shifts around Fonterra Customer customer’s total yearly requirements Service Centre. of Inhalation Grade Lactose (IGL) and the clock, and in eight different to be their preferred supplier for languages so that no matter where opening give a Tablet Grade Lactose, is key to the our customers are in the world, we’re sense of scale long-term strategy of the always there to take their call. Just as with more than PharmaLactose business. That is to importantly, every representative has 27,000 inbound calls and more become the preferred supplier of at their fingertips the database than 50,000 outbound calls, not to pharmaceutical lactose to the world’s containing every customer’s dealings mention the nearly 40,000 faxes multinational pharmaceutical with us, so orders and enquiries can and emails received from October companies. Having IGL supplied from be managed quickly and accurately. to March. New Zealand is important to mitigate customers’ risks. The Fonterra Customer Service Centre is simplifying our customers’ 17

Both forms of lactose, a milk sugar, | interactions with us, while reducing are used as excipients or carriers for costs. It’s a “one stop shop”, active drug formulations contributing centralising ordering, following up to a pharmaceutical lactose customer enquiries, resolving market of US$100 million. problems if they arise and maintaining the links between our customers and

other parts of our business. Best of 2005 ANNUAL REPORT all, the Centre frees up our Global Account Managers so their time is now spent on developing our customer relationships, identifying $25m their needs and developing solutions, NEW PLANT rather than managing orders.

CAREY LEE General Manager, Pharmaceutical Lactose. MAKING DAIRY AN INTEGRAL PART OF PEOPLE’S

SEVEN PATHS TO SEVEN PATHS LEAD IN DAIRY 3 NUTRITION EVERYWHERE

Fonterra Ingredients SEA To meet demand, Fonterra Ingredients South East Asia is a growth market With consumer demand (SEA) General Manager Craig Wilson for us, with strong GDP growth rates growing in Asia, along with the and his team are complementing New helping to increase the local appetite Zealand sourced products with for dairy. Meeting that appetite also appetite for an increasingly product sourced from Fonterra’s becomes easier as market access diverse range of consumer Supply Partnerships around the world. improves, with the Thailand-New products delivering health and This enables them to offer a range of Zealand Closer Economic Partnership nutritional benefits, demand supply options to customers while an example. It has led to phased from our ingredients customers mitigating risk for them. Customers reductions in market tariffs on dairy is on the rise, especially in South can be sure that all products have products and enabled stronger East Asia where Fonterra the same quality standards as relationships to be built with Ingredients achieved record sales those traditionally supplied out of regulatory authorities. this year. Total sales increased by New Zealand and that they will meet 21 per cent from 2003/04. exacting specifications.

21% GROWTH CRAIG WILSON Fonterra Ingredients (SEA) General Manager.

18 | 2005 ANNUAL REPORT Throughout history milk and milk products have been a valuable source of good nutrition in most parts of the world. Fonterra’s owner farmers and our people are united by a common vision to make nutritional dairy products a valued part of people’s eating and drinking habits throughout the world. Dairy products are evolving and adapting to satisfy people’s changing dietary and nutritional needs, to meet their growing prosperity and to match improvements in food standards. Fonterra, a world leader in milk biochemistry, will be at the forefront of this dairy innovation, unlocking the new secrets of milk, to deliver the nutritional, health, convenience and functional benefits of dairy to customers and consumers everywhere. > Tastier Cheese Clinically Proven Results > Indonesia consumers are turning to ANLENE in their search for better bone health. Fonterra Brands’ share of the $100 million Adult Milk category grew to a high of 55 per cent – and this is in a category which itself has grown by more than 30 per cent year on year.

An estimated 20 per cent of Indonesia’s 220 million people have lower than average bone density. High in protein and calcium with less ANLENE has reached out to them sugar than any other spread, with a simple, consistent message Chesdale Cheese slices are the type that the brand delivers clinically of food favoured by parents of proven bone health benefits, using growing children. real stories from local consumers in a But if you’re in a country where testimonial campaign. cheese is not part of the traditional The campaign increased ANLENE diet, some innovative thinking is sales this year by just over required to make it part of every day 50 per cent, a result nutrition. which Fonterra Brands Fonterra Brands in Taiwan has done Indonesia General just that, launching Chesdale Manager, David Ross Chocothin, a chocolate flavoured says demonstrates there is a lot of cheese slice which in just six months opportunity for growth of our bone captured 10 per cent of the expert brand in the Asian region. That Taiwanese cheese market, bringing in performance contributed to a 22 per more than $1 million in revenue. cent increase in Fonterra Brands 19 Indonesian sales in 04/05. | Developed in New Zealand, the cheese was a runaway success, with 9 MT sold each month after launch. Chesdale is a clear market leader in the cheese slice category that accounts for 70-80 per cent of 2005 ANNUAL REPORT Taiwan’s 2,000 MT cheese market. FOR ANLENE With innovations like chocolate 50% + cheese, a partner to the already popular Chesdale Pineapple flavoured DAVID ROSS cheese in Taiwan, we’re giving General Manager, consumers even more reasons to Fonterra Brands (Indonesia). make dairy part of their nutrition. DELIVERING AN INTEGRATED COW TO

SEVEN PATHS TO SEVEN PATHS LEAD IN DAIRY 4 CUSTOMER VALUE CHAIN

Innovative Integration around $17 million a year moving As a Master of Science, some half a million tonnes of product majoring in Logistics and Supply by road to Auckland and Chain, Nigel Jones is pretty Tauranga ports. unrelenting when it comes to A 20 year identifying ways to increase deal with Toll efficiencies and value for our New Zealand, customers and ourselves operators of the New Zealand through closer supply chain rail network is shifting this integration. This year he product from road to rail, slashing and colleagues David transport costs and truck Broad and Kevin Couper movements by 45,000. came up with a real Critical to the project is a 50,000 winner that is reshaping tonne dry dairy store adjacent to the logistics in the Waikato main trunk line in Hamilton and 7km and collected both the from the Te Rapa site. Toll is Fonterra Innovation developing a full-service logistics and Award’s Best Business freight handling facility on site, Process category and the including a container transfer terminal premier Innovation Award and a road distribution/reception area. “The Big Cheese Cup”. The project has leveraged Fonterra’s position as a significant port and The Road to Rail project focused shipping customer, reducing marine on nine sites in the Waikato, and handling charges, as well as where Fonterra was spending mitigating exposure to rising global ocean freight costs.

20 | FEWER 45,000 TRUCK TRIPS

NIGEL JONES

2005 ANNUAL REPORT General Manager, Logistics. Through our integrated cow to customer value chain, Fonterra is the leading global cross border provider of dairy products, able to reliably supply the majority of customers’ dairy needs with the best quality standards at competitive prices. We will be their partner of choice, their research and development arm, earning the right to develop new value-add products and dairy applications. > Investing in Organics Mike Corbett > Fonterra is meeting consumer and With 10 manufacturing LITRES customer demand for organic dairy plants on site, 950 13.6m A DAY products with a US$28 million staff from milk investment aimed at growing New collection to MIKE CORBETT Zealand production. container loading Hub Operations and the capacity to Manager, Whareroa. For Rick Carmont, Global Category process 22 per cent Manager for Organics, the investment of Fonterra engaging with is an important demonstration to our milksolids or 13.6 some of the world’s customers that we’re serious about million litres of milk largest food guaranteeing supply to a market per day at peak, companies in projects which is forecast to be worth US$48 Whareroa is the to align production billion by 2007. world’s largest dairy specifically to their needs. Fonterra’s investment will be used to ingredients The dairy expertise on site fund the premiums paid to farmers manufacturing site. is being applied to who are producing organic milk, or Every hour it can produce customising value-added who have made the three-year more than 42 MT of milk powders, specialist ingredients such as milk commitment needed to convert to 12 MT of drysalt cheese and 10 MT protein concentrates, whey protein organic farming methods. The of mozzarella. Around 100,000 MT of isolates and cream powders as much premiums are part of a strategy to butter also rolls off the production as it is to producing high volumes of achieve 40 farm conversions a year line each year. However Mike dairy ingredients at scale. for the next four years. Corbett, Hub Operations Manager says being big Whareroa’s output includes consumer Fonterra has been in the organics isn’t relevant to products marketed under global market since 2002 and has 17 customers, brands such as ANCHOR, ANLENE, organic specifications in cheese, producing the FERNLEAF, ANDEC and MAINLAND butter, fluid, proteins, blends and milk best is. and the site is a major contributor to powders. As it grows New Zealand the Foodservices segment, producing supply, the Organics business is also The site’s five every gram of the tonnes of growing international supply, working powder plants, mozzarella sold to leading pizza with sources in the USA, Australia two cheese chains and other food outlets around and the European Union to meet plants and the world. plants 21 customer commitments. | producing Whareroa adheres to quality systems cream products, that cover every step of production casein and from on-farm collection to final whey products product grading and dispatch. All of all have one its plants, logistics and technical point of focus departments have ISO 9001 certified 2005 ANNUAL REPORT – customers. quality systems and its three in- Whareroa process and main laboratories are all US$28m is directly accredited to ISO 17025. INVESTMENT

RICK CARMONT Global Account Manager, Organics. MAKING FONTERRA’S BRANDS FIRST CHOICE

SEVEN PATHS TO SEVEN PATHS LEAD IN DAIRY 5

Super Salesman as ensuring our established brands The Coles Myer supermarket like MAINLAND, BEGA, PERFECT chain has 712 Coles and BiLo ITALIANO and WESTERN STAR are in store for customers, Jeff had the stores across Australia. Coles remarkable success of introducing 38 alone buys over five billion new products to the Coles and BiLo products a year to fill more than stores. They included 14 variants of 480 stores. They’re an example Mainland On the Go, the cheese and of many international retail cracker convenience packs, 10 chains who want to deal with variants of Mainland Munchables, a fewer, larger suppliers and insist snack range that’s a hit with children, that only top-performing brands as well as other new BEGA and fill their valuable shelf space. MAINLAND products.

It’s in this tough environment that With Fonterra Brands innovation Jeff Sloan, National Business delivering more than 60 new Manager, won Bonland Dairies’ products into the Australian Salesman of the Year award for his market during the year, Jeff’s work in building Coles Myer into the ability to build Coles’ largest account. Bonland is part of confidence in these new Fonterra Brands Australia and as a products, and deliver supplier to Coles is expected to everyday great service, plays consistently meet Coles’ expectations a big part in our growth. around innovation, quality, cost control, continuous improvement and the highest ethical standards.

Coles Myer supermarkets naturally put their customers first and expect all suppliers to demonstrate there is consumer demand for new products they are looking to introduce. As well

22 |

2005 ANNUAL REPORT NEW PRODUCTS 38 IN STORE JEFF SLOAN National Business Manager, Bonland Dairies. Fonterra’s consumers come from all walks of life in all parts of the world. Our well known and universally-trusted brands are the hallmarks of dairy quality and reliability. They are synonymous with bone health, pregnancy health, child nutrition and goodness. To meet the diverse needs of consumers, to lead innovation and to grow world demand for dairy, Fonterra invests significantly in research and development, communicating the nutritional, health and convenience benefits of dairy to consumers everywhere through our popular global brands.

Fonterra Brands Global they buy, but the business behind the Marketing Director > product. That’s why our consumer business has adopted the name Years of experience with high profile Fonterra Brands, linking our consumer brands in markets as different as the products to Fonterra’s deep dairy UK, the US and Australia make Brett expertise and global reputation. Henshaw a man who knows consumers. Fonterra Brands’ journey involves building on our strengths including As Fonterra Brands’ Global Marketing our strong Australasia and Asian Director, he is now putting that base, strong brand names with global knowledge to good use in the team potential, deep dairy expertise and implementing the strategy to make R&D capabilities and product range our leading brands like ANLENE, spanning all dairy categories. ANCHOR, ANMUM, MAINLAND, Milestones on this journey will include FERNLEAF, TIP TOP, PETERS, BROWNES a new Fonterra endorsement and SOPROLE top performers in appearing on our Power Brands, a our major markets. symbol Brett knows consumers PACKS A In the market today, will, over time, trust as much 2 SECOND competition for consumer as the brands themselves. attention is tough, especially as Anchor : Two Packs a retail chains consolidate Alastair puts this loyalty down to a Second > and reduce the brands host of factors – brand quality, a they stock. Brett It’s always on the consistent advertising message knows that it’s the shelves, it’s never around gold standard nutrition and biggest brands that been out of stock in 30 years of commitment to the win consistent 30 years and it’s a market for a start. He also credits the consumer and brand that sells success story to a motivated sales and retailer two packs of milk distribution team who service the commitment and powder every plethora of small grocery stores that grow rapidly. Equally second in Sri Lanka. make up 90 per cent of the general important to growth is No wonder Anchor trade in Sri Lanka, a very committed consumer trust, not only holds 50 per cent of supply chain team and the support in each product the total market. service received from the marketing, 23 manufacturing, finance and HR team. | Alastair de Raadt, Managing Director of Fonterra Brands (Sri Lanka), is right to be proud of Anchor. In The Sri Lanka

POWERING Institute of Marketing’ Icon 2005 ANNUAL REPORT UP OUR Awards, consumers this year BRANDS voted it the most preferred beverages brand and the BRETT HENSHAW brand with the advertising Fonterra Brands, Global housewives most like. Marketing Director. EMPLOYING AND MOTIVATING TALENTED

SEVEN PATHS TO SEVEN PATHS LEAD IN DAIRY 6 PEOPLE AROUND THE WORLD

Disciplined Innovation resources are focused on those with Peter Munro and colleagues the greatest chance of success. Craig Knox, Andrew Fletcher Phase four prepares the opportunity and Carl Muller of Fonterra for commercial implementation. This Innovation have made a science involves working closely with the of serendipity, an important entity that will ultimately advantage as we work to implement the project, be it become our customers’ partner customers, the Network or of choice in research and Operations. Outputs depend development and accelerate our on the type of project and could include a business own innovation. They led the plan for an incubated project that developed the business, an addition to a Innovation Pipeline, which customer plan, a recognises that ideas for new handover document for products or processes can passing commercialisation come from all corners and to another business unit, sometimes from left field, so or a capital expenditure request. what’s needed is a disciplined The pipeline was designed to ensure way to evaluate them all. our research and development The pipeline has four phases designed spending is targeted, productive and to take an idea from concept to profitable. This year the pipeline commercial reality, with each phase generated 104 approved concepts defining the evaluation needed to and 12 approved options. Six new move the concept forward. Ideas are incubator businesses were also collected in phase one and enriched created. Fonterra Innovation has in phase two where ideas with beaten all targets in delivering potential economic value are handover value or commercial identified for development. Their opportunities from innovations and feasibility is examined in phase three, won the team a Fonterra Innovation with a technical and commercial Award for the Best Business Process. 24 analysis done to identify highly

| valuable concepts and ensure

2005 ANNUAL REPORT BIG 104 IDEAS PETER MUNRO General Manager Planning and Integration, Fonterra Innovation. Our customers and consumers expect the best from Fonterra. We rely on high-performing, talented and experienced people worldwide who choose to join us to deliver on this promise. Through our commitment to our people, reflected in professional development opportunities, market-based remuneration and opportunities for truly global careers, Fonterra will recruit, retain, motivate and reward the best and be their employer of choice.

Rising Star > product quality won the 2005 APV of milk supply by contract milk supply, Invensys Scroll at the New Zealand that our shareholders could mandate Exceptional academic Institute of Food Science and by vote in May 2005. ability, resourceful, Technology/Dairy Industry accountable, a proactive Association of New Zealand The project was the biggest problem solver, self- conference. consultation exercise undertaken in motivated, willing to Fonterra with more than 1,000 farmer experiment, embraces We see people like Alice meetings over four phases and 10 challenge as an as our future and she has months. Fonterra committed to opportunity, focused, been selected for our identify all of the capital structure tenacious – these are just Legacy Leaders issues with shareholders before development programme. developing potential options. The With fellow graduate, process meant farmer feedback was TOP Jonathan Spurway, Alice is also consistently heard and the final TALENT one of 60 young New package put to the vote in May Zealanders chosen for the reflected that. More than 90 per cent ALICE VAN DEN HOUT University of Auckland’s Future of the 62 percent of shareholders Process Development Leaders Programme. voting at the Special Meeting voted in Technologist. favour of the changes which will Capital Effort > come into effect at the start of the 2006/07 season. some of the qualities Fonterra’s deep dairy we look for when we expertise goes well beyond Cross functional teams like these are select people for the our ability to collect, process a way of life in Fonterra as we let our Fonterra Graduate and market milk, as this year’s best talent loose on projects to grow Technical Programme. major capital structure project our business and our performance testified. A core cross-functional while drawing on the insights and It’s a tall order, but every year, we find team of 20 staff with the knowledge commitment of our farmers. talented people like Process needed in law, finance, strategy, Development Technologist Alice van shareholder services and den Hout who are capable of communications worked alongside thriving in our intensive one-year, one of the project’s leaders, Alex post-graduate course that culminates Duncan of Fonterra’s Economics team in a Master of Dairy Science and to identify and work through Technology. 25

Fonterra’s capital structure issues. |

Alice is based at Edendale, working They worked alongside the Board’s with the heat transfer and drying Milk Pricing Working Group and team to improve milk powder plant the Shareholders’ Council to performance. The report of her develop a proposal, research project on anhydrous milk including securing fat (AMF) plant performance and up to 15 per cent 2005 ANNUAL REPORT

1000 + MEETINGS 60% + PARTICIPATION 90% + APPROVAL

ALEX DUNCAN Director Economics. WINNING AND RETAINING THE LOYALTY

SEVEN PATHS TO SEVEN PATHS LEAD IN DAIRY 7 OF SHAREHOLDERS

Cream of the Crop The judges described Greg and Rachel They are proactive in animal welfare With Fonterra targeting milk as “real ambassadors to our industry” issues and their plans for the future growth of three per cent per with industry leading farm system are focused around expanding their analysis and monitoring and a culture farm ownership and building equity annum, the capability and of excellence in every aspect of while running an efficient business loyalty of shareholders like Greg the business. and creating wealth in a and Rachel Roadley, winners of sustainable way. the premier Farm Business of “They are achieving quality assets, the Year in the Fonterra quality systems, and quality cows Westpac Dairy Excellence producing a superior product. They Awards, is vital to our growth. are very customer focused farmers,” the judges said. The young couple in their thirties, In many ways Greg and Rachel both Bachelors of Agricultural epitomise the foundation Science, are driven by the constant theme of sustainability in challenge to improve their farm and Fonterra’s Strategy which business efficiency. It’s a challenge emphasises shareholders they have met head on, with the following sustainable judges in the awards at a loss to find practices, getting any areas for improvement in their the best returns 1,240 cow operation near Ashburton. and growing their In addition to the overall title, milk supply. Greg and Rachel also won the Livestock Improvement Corporation Productivity Award, and the DTS Environmental Integrity and Quality Management Award.

26 |

2005 ANNUAL REPORT AT THE 2 TOP GREG AND RACHEL ROADLEY Shareholders and Fonterra Westpac Dairy Excellence Award winners. Fonterra’s business is based on our farmer shareholders’ milk and their capital. As a co-operative, we strive to make their milk more valuable and increase the value of their investment in Fonterra.

RD1 – John Lea > involved in the process. For customers Small at home to be and staff, the business model big in the world > RD1 Chief Executive, John Lea has a promising “low prices, great service” simple goal for the rural retail Shareholder loyalty is was rolled out in RD1’s 51 stores in business. He wants to win Fonterra important to our September 2004. shareholders’ loyalty and trust. Just as sustainability and people like Phil the old-style co-op stores were RD1 sharpened its competitive edge Griffiths, one of our regarded as partners to generations through efficiencies that took $3 Field Rep team, play of dairy farmers, RD1 wants to see million in costs out of the business an important role. Fonterra shareholders leveraging their and enabled up to 16,000 stock units considerable on-farm expenditure to be repriced in each store over one through a partner they own and trust. weekend to deliver on the “low prices” promise. The company also To win that loyalty requires giving TARGET launched a Price Promise. Now RD1 dairy farmers what they most want in monitors market prices daily and their local RD1 outlet. So before 200 makes changes to keep that price talking about earning trust, John and promise to Fonterra farmers, reacting his team listened to over 2,000 PHIL GRIFFITHS to the market and most importantly, farmers from Kaitaia in the north to customer needs. In April 2005, RD1 Field Rep. Invercargill in the south, 1,200 of rolled out its CountryMile housebrand them Fonterra shareholders. to further reinforce its price They are the face of Farmers talk plainly and the message competitiveness and improved choice. Fonterra at our to John was clear; “give us farmers’ front Loyalty and trust aren’t won competitive prices, good service and doors, sorting out overnight, but RD1 looks to be the full range of products and we will any issues and helping them gain a making good headway. Farmer support you.” RD1 spent three better understanding of our business, feedback is good, store managers are months performance and direction. We seeing an increase in traffic and that developing its expect them to listen too, because old “co-op store” sense of ownership new business feedback helps to identify potential is beginning to emerge again among model, with issues and opportunities to improve farmers. Best of all, their support for every part of our service and our relationship. their “co-op store” is contributing to the company increased profitability in RD1, which Phil says there’s an added contributes to Fonterra’s overall responsibility he calls “sharing the 27

revenues. In the very competitive rural vision” – making sure our | retail market RD1 has emerged as a shareholders understand what their top financial performer. There is investment in Fonterra is doing for plenty more to come. The more them and that they understand our loyalty RD1 gets from Fonterra direction and the enthusiasm of the farmers, the better it can leverage management team behind it. He says

its buying power for them. “passing on some of the excitement” 2005 ANNUAL REPORT is just as important as sharing farming knowledge. 51 ONE Phil’s patch is North Canterbury and STORES PROMISE he aims to achieve 200 two-hour “full value” visits with farmers every JOHN LEA season. These, alongside day-to-day contact, are all part of keeping Chief Executive, RD1. shareholders in touch with Fonterra, and Fonterra in touch with them. OPERATIONAL REVIEW

Fonterra Ingredients international competitiveness as a standardising our processes across As it delivered a sound result for the manufacturer of low cost dairy all our sites. 04/05 season, Fonterra Ingredients products at scale is retained. An example of the breadth of work intensified its focus on securing Operations Journey has set about being undertaken comes in the area Fonterra’s competitive advantage as a doing that through five work streams of Operational Excellence. This low cost producer at scale. aimed at: encompasses programmes such as The single most important Manufacturing Excellence (ME) and • making sure we get the best out of achievement this season was the Maintenance Best Practice (MBP). our current manufacturing mix finalisation of our JEDI programme ME is being rolled out to our key that has streamlined how product is • ensuring we have the right blend of major sites of Te Rapa, Whareroa, ordered, supplied and paid for and people, information and systems to Clandeboye and Edendale while touched every corner of Fonterra, optimise our performance coaches have been recruited to take from manufacturing to production the programme to all sites by the forecasting, inventory management • becoming the preferred business end of 2006. and customer relationships. partner for our customers internationally when it comes to Key steps implementing MBP will also The system and processes were manufacturing be in place by the end of 2006 while successfully rolled out during the year site Energy Reduction Programmes to Latin America, Oceania (New • ensuring that any new and Clean in Place (CIP) best practice Zealand), Fonterra Global Accounts, developments in our specialist are already bringing results. The Africa, Europe, the Middle East and manufacturing fields are quickly Supply Chain Excellence programme Asia. Post balance date the global rolled out through the business. is in its formative stages. rollout was completed, taking Under Operations Journey there are All of these programmes will bring Fonterra into a new era in the way programmes aimed at improving the bottom-line benefits to Fonterra but we conduct business globally. skills of our people, simplifying access represent just a sample of the work The programme has delivered to information needed to make underway in the Operations Journey. manufacturing efficiencies, manufacturing decisions, and streamlined our supply chain, enabled procurement savings and is lowering our costs of serving our customers, FIRST TIME GRADING

% while simplifying our transactions GRADE with them. Having introduced 100 28 2004 – 2005

| significant efficiencies to the business 90 SEASON through this programme, we are not 80 2003 – 2004 SEASON letting up on our efforts to achieve 70 operational excellence. Our 60 Operations Journey programme, 50 which includes a Manufacturing 1 5 91317212529333741454953WEEKS

2005 ANNUAL REPORT Excellence programme, is already underway.

Outstanding results around First Time Right First Time Grading and Yields are the most Fonterra has made significant ground in improving first time grading immediately visible benefits of the performance this year, with the end of season result of 93 per cent first year of our Operations Journey, compared to 78 per cent for the previous year. This achievement added 1.4 but there are a raft of programmes cents per kilogram of milk solids to payout. Yield performance, also critical behind the Journey that have already to the success of our manufacturing sites has also improved significantly brought financial benefits to Fonterra. over the past three years with total losses improving 18 per cent since 2003. This is predicted to continue as focus will be getting the maximum That’s in year one of a five year utilisation of the milk solids supplied. programme which will ensure our Fonterra Brands At the heart of this strategy are the Alongside the work to drive up the As it drove hard to hit budget targets in high-value brands in its portfolio. value-add earnings from our brands, tough market conditions, our brands While Fonterra Brands has around Fonterra Brands is working to drive business also made significant progress 100 brands on its books, it is the top costs down in its supply chain. in the year to create a new and 20 that generate around 80 per cent Opportunities have been identified stronger platform for value-add growth. of revenue. for a major shift in both costs and effectiveness in manufacturing, Since September 2004 the business Fonterra Brands has introduced a procurement, product sourcing has been led by Sanjay Khosla as Power Brand strategy which will see and logistics to achieve ongoing Managing Director, a global brands our top brands receive higher annual savings. expert who joined Fonterra after an investment so they deliver faster outstanding international career with growth and better margins. Lower Fonterra Brands’ intensified focus on Unilever. He has a very successful performing brands will be rationalised Foodservices is already delivering track record in building global brands. to reduce the total portfolio, further results, with earnings targets focusing resources to ensure better exceeded through favourable Since his appointment the business returns. The goal is to take Power margins, lower costs and good has developed a clear growth Brands to the #1 or #2 position in growth in Asia. strategy, now underway, and changed major markets. its name to Fonterra Brands, giving it Fonterra Foodservices and its branded products a clearer Our Power Brand positions build on connection to Fonterra’s dairy our proven expertise in cheese This year, Fonterra embarked on a expertise and international strength. craftsmanship, bone health, maternity process to understand how it could and infant health, family nutrition and better serve the needs of customers in Fonterra Brands has developed a clear the indulgence market typified by ice the foodservice segment, including strategy Winning Through Brands! creams and dairy desserts. They cover bakeries, quick service restaurants, with three areas of focus; investing in our leading international and regional hotels, airlines, cafes and restaurants. our top-performing brands to grow brands; FERNLEAF, ANCHOR, Today’s foodservice operators face their market share, driving aggressive SOPROLE, BROWNES, DOS ALAMOS, growth in foodservices and achieving ever increasing consumer demands

29 | 2005 ANNUAL REPORT

supply chain efficiencies that will MAINLAND, ANLENE, ANMUM, TIP for quality and tasty food, presenting lower costs. TOP AND PETERS. Their growth, good value for money, with a high financial performance and market degree of choice and customisation, Our goal is to create superior value position will be supported by a higher to be delivered fresh and rapidly and for our shareholders by building investment in innovation. Global in a variety of forms. great profitable brands which brand and innovation teams have delight consumers. already been established. OPERATIONAL REVIEW – Continued

The depth and breadth of Fonterra’s million to revenues this year, a stable five main categories of specialty dairy offering means we are well performance in a year where their products it sells to the convenience positioned to be a partner to a range input costs rose as a result of higher food and prepared dairy market. of foodservice operators, from major commodity prices. restaurant chains that include our The 2004 - 2005 year confirmed that cheese in their hamburgers, to small One highlight of the season included we have an attractive set of cafes that stock our pastry products, the October opening of the milk businesses with strong organic through to airline catering kitchens protein fractionation plant at growth opportunities. They have the who are looking for convenient, pre- Hautapu, which will initially be used full support of the Board and senior packaged portions. for extracting lactoferrin, one of the management and as a distinct specialty ingredients marketed by our business group are now better A global foodservices team was Health and Nutrition business which structured to succeed in driving established this year in Melbourne to specialises in nutritional solutions increased value-add results. develop specialised responses to using dairy. support the foodservice customers. Another highlight was, the opening Fonterra Innovation The team works in conjunction with of the Inhalation Grade Lactose (IGL) Formerly part of Fonterra Ingredients, Fonterra Brands personnel in over 70 plant at Kapuni. The plant opened Marketing & Innovation has now countries to meet the needs of with an agreement to supply a become part of the standalone foodservice customers. leading pharmaceutical company with Fonterra Innovation, created to allow The team brings together products a significant proportion of its total Fonterra to use and leverage its from both Fonterra Ingredients and yearly requirements for IGL and is research and development capabilities Fonterra Brands to provide a now also a preferred supplier of its and deep dairy knowledge across the comprehensive suite of offerings for tablet grade lactose. entire business. the modern commercial kitchen. Since Both plants represent significant Fonterra Innovation began to its establishment, the team has advances in Fonterra’s manufacturing demonstrate its considerable value- initiated research and development capabilities for specialty products. creating potential in the 04/05 projects to improve the packaging, Extraction of lactoferrin, for example, season, more than doubling the net storage and performance of products is just the first step in developing present value (NPV) of projects in a way to meet the needs of Fonterra’s capability to extract delivered for commercialisation in its foodservice operators and to develop bioactives which are high value, second year of operation. a range of ready-to-use dairy products minute components of milk. They are to save operators time and money. beneficial to human health and are a NPV measures the present value of an Fonterra is committed to the major driver of Fonterra’s value-add innovation’s expected future net cash growth of foodservice and to ingredients business in key markets. flows, less the initial development providing customers with tailored investment. Fonterra Innovation’s The Organics business secured Board products and solutions that support performance was achieved through endorsement to invest in significant their businesses needs. innovation projects focused on three supply growth to meet unsatisfied areas – new products, cost reductions demand, while Fresh Dairy and cost avoidance. New products

30 | 2005 ANNUAL REPORT

Fonterra Specialty Products consolidated its global operations, represented the greatest proportion Fonterra’s portfolio of five specialty developing a promising pipeline of of the value delivered. products businesses are a key part of large opportunities with major Among the milestones for the year Fonterra’s value-add strategy in multinational customers for was the development of six new ingredients. Organics, PharmaLactose specialised solutions in cultured dairy incubator businesses. An example is Fresh Dairy, DairiConcepts and Health products. DairiConcepts gained new and Nutrition have contributed $516 business in cheese flavours, one of the Formulated Milk incubator business which is aiming to be the the feasibility of a system that would Increased proactivity on our part partner of choice for regional dairy enable consumers to choose a snack includes how we can assist on-farm in marketers looking to initiate or extend formulated for their health needs, such helping profitability and milk growth, their range of premium milks. The as low fat for calorie management, low as well as what we can do on a business is building on Fonterra’s cholesterol for heart health or high national scale to address issues capabilities and intellectual property calcium for bone health. affecting farming, including rising in processing and formulating energy costs, increasing competition recombined milks and in its first eight Fonterra Milk Supply for resources like water and ensuring months of operation achieved US$7.6 Maintaining the quality and quantity recognition of dairy’s economic million in new revenue. of low-cost milk supply in New importance to New Zealand. Zealand over the long term is basic to The main target markets for To reflect this increased role in Formulated Milks are Asia, particularly driving and encouraging milk supply China and the Middle East. Its range growth and providing additional of nutritionally enhanced milk support to our farmers, Shareholder formulations includes Junior (a milk for Services has changed its name to 3-10 year olds with additional iron, Fonterra Milk Supply. protein, Vitamin C, Vitamin D and 82% The new name more accurately calcium), Nurture (a milk for pregnant SATISFACTION reflects what this part of the business women with added iron, folate and has been doing since Fonterra began calcium) and Silver (a milk for active – that is looking after all our suppliers seniors with extra calcium and Vitamins with Fonterra Milk and their milk supply needs across a D and B12). Other formulations include Supply services. wide range of services. products containing non-dairy protein such as rice and soy milks, a specially Our growth relies on the loyalty and formulated milk suitable for people with Fonterra’s international confidence of our shareholders so as Type 2 diabetes and dulce de leche, a competitiveness. Fonterra has we have worked this year to caramel flavoured ingredient for use in recognised the importance of milk determine what we can do to support a range of dairy-based desserts. growth in our strategy, particularly in higher productivity, we have also the foundation theme which stresses tested shareholder satisfaction with Fonterra Innovation also created the importance we place on being a where we are now. Of the farmers external research partnerships focused sustainable co-operative. surveyed, 65 per cent rated our on increasing opportunities for value- performance as very good or add dairy products which can deliver This sustainability theme not only excellent, 67 per cent had confidence specific health benefits to consumers. recognises the importance of growing supply by three per cent each year, in our direction and 80 per cent In June 2004, in partnership with BASF, but also the importance of our believed we would make changes for it initiated a four-year research project farmers following sustainable farming the better over the next three years. with Massey University’s Ridett Centre practices. At the same time, making The results are a marked contrast to which aims to pioneer a system to the commitment to sustainability the benchmark survey of 2003 where

31 | 2005 ANNUAL REPORT

create fast, nutritious snacks tailored to opens the door for Fonterra to just 17 per cent of farmers ranked individuals’ dietary needs. Called become more proactive in all the Fonterra’s performance as very good POSIFOODS (point of sale individualised areas which will support year-on-year or excellent. foods) the project is combining nutrition milk growth which not only enables science, innovative food processing and us to increase production to meet The 2005 result also shows continued formulation process with state-of-the- growing demand, but also brings new satisfaction with the performance of art vending technologies. It aims to capital into the business through our Fonterra Milk Supply services, with develop working prototypes to prove Fair Value Shares. OPERATIONAL REVIEW – Continued

82 per cent of owners in the very farms. Dexcel’s growth goals are also and customer focus. As a result, good or excellent category and just ours, and the new management Fonterra formed action learning one per cent rating the service as agreement is designed to support real teams to develop recommendations poor or not very good. progress towards them. Under the and solutions for these areas. The agreement, Dexcel management will teams consist of future leaders right The results are encouraging, especially report into a nominated Fonterra across the business who are working as Fonterra Milk Supply will drive many senior manager with Fonterra together researching, benchmarking of the initiatives aimed at growing milk responsible for delivering on strategy best practices inside Fonterra and in supply and ensuring the co-operative to Dexcel’s Board of Trustees. The other companies, soliciting employee model continues to work well for our resources of Fonterra Milk Supply will and management input, and shareholders and encourages them to also be available to Dexcel which consulting with experts in the field. stay with us. Progress was made this retains its standalone status. Their recommendations are scheduled year and will accelerate in the coming to be delivered back to management season under the leadership of Barry in October 2005. Harris, who in June 2005 joined the co- Fonterra Support Services operative as Director Fonterra Milk Fonterra Support Services comprises Supply to replace Barry O’Donnell on his the human resources, strategy, planned retirement in December 2005. finance, legal, trade, communications and information technology services Barry Harris has a background that support our global business. focused on issues of sustainability, FIRST particularly in the agricultural sector, In HR, a highlight for the year was employee survey an area that is of increasing Fonterra’s first employee survey, importance to Fonterra. He is administered late in 2004 and gives positive ratings. experienced at leading large teams involving about half of Fonterra’s New through complex pieces of business Zealand and international employees. Almost 70% of those receiving the that affect and deal with a wide During the year, Fonterra continued questionnaire responded. range of audiences. That’s the to focus on employee development, experience we need in dealing with The findings – which were particularly programmes to identify our farmers, the myriad of issues independently analysed, and and train future leaders. The year saw that affect their business and in benchmarked against our Fonterra’s Legacy Leaders programme managing our farmer support and international peers in manufacturing introduced which will involve up to transport networks. and consumer businesses – have 30 Fonterra employees at each four In addition to the major and very provided us with valuable information day programme. It recognises that our successful capital structure project on the way we see ourselves and the long term performance and undertaken this year, Fonterra Milk areas in which we must strive to lift sustainability depends on having the Supply began targeting better our performance. It identified several leaders with the skills to deal with the alignment of research spending with areas where attitudes are much more issues and challenges that are unique productivity goals, leading to a three- positive than the average among to us as a global dairy co-operative. year management agreement for benchmarked companies, including

32 | 2005 ANNUAL REPORT

Fonterra to provide strategic health and safety, immediate Fonterra’s finance team was assistance and management management, values, employee strengthened during the year with the services to Dexcel. engagement, job satisfaction, morale, appointment of Guy Cowan as Chief training and development. Financial Officer. He joined Fonterra in Dexcel, which is 100 per cent owned March 2005 following a 23-year by New Zealand dairy farmers, was The results also identified areas where career with Shell Oil Company during established to increase sustainable Fonterra needs to improve including which his last positions were Vice productivity of New Zealand dairy internal communications, innovation, President Finance and Chief Financial newly implemented EDS Disaster The Government and Trade Team also Officer for Shell Oil Company in the Recovery systems were successfully established a new team in the area of US. He was also a Director of Shell tested during Hurricane Francis in the customs compliance where Fonterra Petroleum Incorporated. Americas and a factory flood in routinely deals with more than 5,000 New Zealand. different export classifications as a He has brought to Fonterra a strong global trader. The Customs track record across a wide range of In 2005 the visibility of this major IT Compliance Team has been created to business disciplines relevant to the implementation throughout the ensure we achieve the highest levels business, including international Fonterra business will be increased as of tariff compliance and is overseen experience in the financial the “Switched on Technology” by a Customs Council. A separate management of a complex and programme of work is rolled out. This Optimisation Team has been geographically diverse multi-national will see over 10,000 desktops and established in Fonterra Ingredients to business and knowledge of laptops (and 14,000 users) moved to a maximise opportunities to increase commodity markets, mergers and standard suite of applications through trade opportunities. acquisitions, risk management and the entire Fonterra organisation. treasury operations. Significant business outcomes The Customs Compliance Team will supporting the Fonterra strategies will manage tariff classification and customs Fonterra’s Strategy and Growth team be realised through the provision of valuation risk and provide world best- led the project which evaluated and greater global capacity and consistency practice compliance capabilities to refreshed Fonterra’s strategy, rolled out of IS services – access to reliable and operating companies. The Customs in 2001. It considered the strategy in secure current and future technology, Council is made up of senior the context of science and technology the ability to work smarter with representatives of Fonterra Ingredients, trends, global and economic trends, increased mobility, and resultant S&OP, Fonterra Brands, Fonterra developments in dairy and our own productivity gains to maximise value Innovation, Group Taxation and capabilities. This refresh project returns for shareholders. Government and Trade. confirmed Fonterra’s Strategy is fundamentally sound but also Information Services achievements in Fonterra Communications continued identified opportunities for refinement, 2004 included support of Project JEDI to focus on keeping shareholders, including the inclusion of a new and transition of the project phases to employees, stakeholders and the New foundation theme of sustainability. This business as usual. The improvements Zealand and international media reinforces the importance we place on made through this project touch every informed of developments in the being a sustainable co-operative, with part of the business, with the business. This includes Fonterra’s our farmers following sustainable Information Services team providing publications for farmers and staff. practices, getting the best returns and continuing support to these processes. Major work undertaken included the growing their milk supply. capital structure consultation round, Fonterra’s Government and Trade support for change programmes in Fonterra completed the first year of team, in a joint project with Fonterra such as our global supply our seven-year contract with EDS Knowledge Services, developed a chain rollout, Operations Journey, which outsourced the provision and Global Dairy Information (GDI) communication surrounding maintenance of our global information intranet database for launch in June Fonterra’s investments, mergers and technology infrastructure. 2005. GDI provides a central,

33 | 2005 ANNUAL REPORT

During 2004, EDS significantly consistent set of key data on dairy acquisitions, particularly in Australia, upgraded the IT network, developed production, prices, trade and tariff and increased focus on internal disaster recovery systems and rates, which will improve the quality communications including the implemented a global helpdesk system and integrity of our strategic and establishment of a global based in New Zealand and supported financial decision-making. communications network to by satellite facilities in Mexico and strengthen Fonterra’s culture. Kuala Lumpur. The robustness of the PERFORMANCE MEASURES

Fonterra has adopted a set of economic measures to assist shareholders to assess our performance. They were created because Fonterra does not have a New Zealand based competitor of similar size and scale against which our performance can be effectively benchmarked, nor do we have a market based price for the milk which is our principal cost input.

Fair Value Share investment to shareholders. In a The TSR analysis above takes into The Fair Value Share comprises the conventional listed company TSR is account the full value of hedging underlying value of the core business the total return, comprising dividends gains in the fair value of a Fonterra and any gains (or losses) attributable paid and any change in the share share. To assess the TSR from to foreign exchange contracts price over the past year, divided by Fonterra’s core business operations, it hedging payout for the 05/06 season. the shareholder’s investment at the is informative to eliminate from the The underlying value of the core start of the year. Fair Value Share at year end any gains business is represented by the net (or losses) arising from hedging As a co-operative, Fonterra does not present value of the expected future contracts that support the payout for pay out dividends, but typically value add returns to shareholders. milk to be supplied in the following distributes virtually all of its income to These are the expected returns to season. The hedging gains that shareholders in the form of payout. shareholders in the future over and support milk to be supplied next For the purposes of determining a above the value of their milk at the season are significantly less than the TSR for Fonterra, total return is farm gate, as determined by the comparable hedging gains figure for defined as payout less the Historical independent valuer. last season. Accordingly, the TSR for Commodity Milk Price (“CMP”) plus FY05 excluding these hedging gains is Our Fair Value Share rose by 16 per the appreciation in the Fair Value 19.4 per cent compared with 11.1 cent from $4.69 to $5.44 for the Share over the year. Investment is per cent last year. The corresponding 05/06 season. This is the fourth defined as a shareholder’s investment annual compound average TSR for annual increase and confirms for at the start of the year, comprising the last three years is 13.8 per cent farmers the strong financial return both the Fair Value Share and which is broadly consistent with the from their investment in the Peak Notes. three year average including all co-operative. Total returns for 04/05 were 97 cents hedging gains of 14.1 per cent. per kilogram milk solids, comprising a 34 Appointed by the Shareholder’s

| Council, Standard & Poor’s Corporate TSR Value Add component of 22 Milk Price Gap Value Consulting (Standard & Poor’s cents and an increase in the fair value The Milk Price Gap (the “Gap”) is a CVC) independently valued each of a Fonterra share of 75 cents over performance measure aimed at share at between $5.03 and $5.85, the year. Dividing the total return comparing the performance of compared with a range of $4.34 to earned by the opening investment Fonterra’s business with that of the $5.05 for the 04/05 season. The results in a TSR for the current season hypothetical efficient competitor, on of 17.2 per cent. This compares to a 2005 ANNUAL REPORT major factor behind the increase was the assumption that both only the independent valuer’s recognition TSR of 11.0 per cent for the 03/04 produce commodity products. The of some of the expected future gains season and 16.7 per cent for the Gap is measured as the difference from Fonterra’s medium term strategy 02/03 season. between the Historical CMP and the for transforming the operational Fonterra CMP (see definitions in the It is preferable to measure TSR over a performance of the Fonterra box on page 35). number of years, which helps to Ingredients business. smooth out the effects of short term The FY05 Historical CMP is assessed volatility in currencies and commodity at $4.37 per kilogram of milk solids Total Shareholder Return prices and lumpiness in reported and the Fonterra CMP is assessed at Total Shareholder Return (TSR) is a profits. Fonterra’s annual compound $4.14 per kilogram of milk solids. well-recognised measure for average TSR for the last three years is Accordingly the FY05 Milk Price Gap evaluating the total return on 14.1 per cent. This represents a is calculated at 23 cents. strong return to our shareholders. This compares to a FY04 Milk Price increase in capital costs was an and Fonterra CMP, both of which Gap of 20 cents. increase in inventory held by involve a significant number of Fonterra. Part of the reason for subjective judgements and There are a large number of holding increased inventory is to assumptions. It is therefore doubtful components in the Historical CMP ensure that Fonterra can supply its whether either measure can be and Fonterra CMP that can affect the key customers 12 months of the reliably determined with a margin of Gap including differences in installed year. The hypothetical efficient error of one per cent of the Fonterra plant, plant utilisation, product competitor is assumed to sell in line CMP. Accordingly, it is not appropriate mix, working capital and with the milk curve through agents to place too much reliance on small operating expenses. and therefore is not concerned movements in the Gap, which is the The key drivers in the adverse about continuity of supply to key product of both the Historical CMP movement in the Gap between FY04 customers or balancing supply with and the Fonterra CMP. demand, even in the short term. and FY05 are: Notwithstanding these issues, • Improved yields and quality in the Although the Gap has increased by Fonterra will continue to analyse the Fonterra CMP reduced the Gap by three cents to 23 cents per kilogram Gap to identify areas where two cents. of milksolids it must be recognised improvements within its control can that this increase is less than one per be achieved. Fonterra will also • Additional capital costs in the cent of the Fonterra CMP of $4.14. continue to seek alternative, more Fonterra CMP increased the Gap by There are inherent limitations in the robust, measures of long- five cents. The key element of this measurement of the Historical CMP term efficiency.

Historical CMP The Historical CMP is based upon the CMP assumptions determined by Standard & Poor’s CVC as part of their Fair Value Share assessment at the start of the year. The CMP is the price a hypothetical efficient competitor could afford to pay for milk and is assessed as: Annual revenue that could reasonably be achieved from the sale of a balanced portfolio of dairy commodity products, derived from milk, of the quality and quantity supplied to Fonterra in New Zealand at the same base commodity prices as actually achieved by Fonterra. 35 | Less: The assessed operating costs and capital costs (including a fair return on capital) incurred in deriving that commodity milk revenue. The hypothetical efficient competitor is free to completely reconfigure its plant each year having regard to developments in technology and changes in long run market expectations of returns from particular commodities which are, of course, then reflected in its operating and capital costs.

In other words the CMP is the residual available to pay for milk after deducting the estimated commodity costs from the 2005 ANNUAL REPORT estimated commodity revenue. For the purposes of assessing the Historical CMP the CMP assessed by Standard & Poor’s at the start of the year is updated for the actual milk volumes, base commodity prices and exchange rates achieved by Fonterra during the FY05 season.

Fonterra CMP The Fonterra CMP is calculated in a similar manner to the Historical CMP. The Fonterra CMP is the estimated payment for milk that Fonterra would have been able to make to enable it to recover all its costs, including a fair return on capital. It is based upon the actual volume of milk solids received during the year but assumes that only commodity products are manufactured. All milk volumes actually applied by Fonterra to manufacture non-commodity and value add products are assumed to be applied to the manufacture of commodity products and are assumed to be sold at base commodity product prices. Accordingly the Fonterra CMP excludes any value earned by Fonterra from value add activities. CORPORATE GOVERNANCE

Fonterra is New Zealand’s largest co- consultation with shareholders. The performance of the CEO; engagement operative as well as being a election process for Directors has already in the strategic planning process and in significant company in the context of been the subject of a review by the the setting of the strategy for the the New Zealand economy and the Shareholders’ Council to help ensure the Company and the major business units; global dairy industry. capabilities of the Board meet the needs approval of significant acquisitions and of the co-operative and the challenges disposals outside management’s The Company has over 11,000 New of being a global leader in dairy. The delegated authorities; oversight of the Zealand dairy farmers suppliers who are Council has also engaged in significant Board Committees and the areas shareholders and has issued Capital consultation with shareholders in covered by each of those Committees. Notes which are listed on the New this regard. Zealand Debt Market of New Zealand The Board has issued a written Exchange Limited (“NZX”). “Independent directors”: The Fonterra delegation of authority to Management, Constitution specifies the composition which it regularly reviews, and has The Board and Management are of the Board and does not distinguish reporting and review processes in place committed to a system of corporate between “independent” and “non- to monitor performance of governance that meets the unique independent” directors. The Appointed Management in the conduct of the requirements of Fonterra’s shareholders Directors are “independent” and free of operations of the Company. and best practice appropriate to a co- any supplier relationship with the operative, and, as New Zealand’s biggest Company. However, the co-operative The Board has adopted a Charter, which company, also takes into account nature of the Company means that defines its manner of operation and recommendations by the New Zealand Elected Directors, who must be relationship with Management. A Securities Commission and NZX. shareholders, will have a supplier process exists to regularly review this relationship with the Company. While document to ensure that it reflects the role of the Board as it develops. The Board of Fonterra none of the Elected Directors are material shareholders, they are not Composition: The Board is comprised classified as “independent” under the of up to thirteen directors. Under the Board Meetings NZX definitions because their supplier Fonterra Constitution, nine of the The Board meets formally at least eight relationship with Fonterra is material to directors are elected from the times each year to conduct business. their business activity. shareholder base (“Elected Directors”), The business at those meetings includes and four are appointed by the Board The Board considers that the mix of consideration of the ongoing operations and approved by shareholders at the Elected and Appointed Directors, as of the Fonterra business, long term and Annual Meeting (“Appointed mandated in the Constitution, provides annual plans and budgets, major Directors”). There are no executive an appropriate balance so that the strategic proposals and governance directors. Board operates in the best interests of matters (including statutory the co-operative’s shareholders. responsibilities and continuous Appointed Directors have a significant disclosure issues). 36 role to play in providing a balance of All Directors comply with the legislative | independence, skills and experience to requirements for disclosing interests, The Board also holds a number of the Board, complementing the deep and Fonterra has a Securities Code of workshops to consider matters of understanding of the dairy industry Conduct, which guides and regulates significance such as the Fonterra provided by the Elected Directors. both Directors and Management Strategy and the capital structure. In Consequently, appointments are only in their personal dealings with addition, Directors undertake market made after a process involving an Fonterra securities and those of visits to significant global markets to extensive search based on detailed related companies. enhance their understanding of the 2005 ANNUAL REPORT criteria and an interview programme. business of the Company and its Appointed Directors are appointed for a Board Role & Charter: The Board has strategies. These market visits include term specified by the Board, subject to the responsibility to direct and supervise briefings from management and shareholder approval. Elected Directors the management of the business and meetings with joint venture partners, are appointed for a three-year period affairs of the co-operative. Key activities major customers and local through a postal ballot. in discharging this responsibility are: political leaders. determination of payout; setting of the The composition of the Board is a Fair Value Share price after significant element in the Fonterra determination of the Fair Value range by governance system. As Fonterra matures the Valuer; review and approval of the and changes it may be appropriate to budget and corporate plan; the review the structure of the Board in appointment and review of the Board Committees of financial risk strategies, The Chairmen of the Shareholders’ The Board uses Committees or Working hedging policies and other Council, and of the Performance Groups to facilitate more effective and treasury functions; ensuring the Committee of the Shareholders’ efficient decision-making. Committees timeliness and balance of Council, are entitled to attend as and Working Groups have written terms disclosures on the affairs of the observers. The Chairman of the FVS of reference, and report on their Company; oversight of the Committee is Roger France. The activities to the Board. Committee appointment of external auditors principal activity of the FVS members are Directors only, although and the external audit process. Committee is providing advice to the other people may be present as • Appointments Remuneration and Board on the setting of the Fair Value observers, whereas Working Groups Development Committee (“ARD Share price, which the Board is may have employees, shareholders, Committee”): The ARD Committee is required to do under the or others as members in addition comprised of five Directors, two of Constitution. In order to fulfil this to Directors. whom are Appointed Directors. The role the FVS Committee reviews Chairman of the Committee is the information provided by Management The Terms of Reference and Chairman of the Board, Henry van to the Valuer, and interacts with the membership of each Committee or der Heyden. Principal activities of the Valuer to the extent required to Working Group are reviewed annually ARD Committee include obtaining enable the Committee to understand by the Board. There are currently five assurance that the Company’s human the valuation method, assumptions, permanent Committees of the Board resources policies and practices and models used in the determination and one Working Group, as identified support achievement of the of the Fair Value Range. below. Ad hoc committees may be Company’s goals; overseeing • External Relations Committee: formed as required, for example, in appointments of the CEO, roles The External Relations Committee is the event of major merger and reporting to the CEO, and key comprised of three Directors. The acquisition activity. professional advisors in the area of Chairman of the Committee is the Legal and Public Relations; reviewing Chairman of the Board, Henry van • Audit, Finance & Risk Committee remuneration strategies and plans; der Heyden. (“AFRC”): The AFRC is comprised of and overseeing the development of at least five Directors, and must The purpose of the Committee is to key employees. The Committee is also include an Appointed Director and assist the Board in building developing processes for evaluation the Chairman of the Company. At relationships with political contacts of individual Directors and the Board least one member of the Committee and international trade policy as a whole. is required to have an accounting or contacts as well as with selected joint financial background. The Chairman • Shareholder Relations Committee venture partners. of the Committee (who must not be (“SRC”): The SRC is comprised of • Milk Pricing Working Group the Board Chairman) is Graeme four Directors. Four Shareholder (“MPWG”): The MPWG is comprised Hawkins. Both he and Roger France, Councillors also attend SRC meetings of four Directors, up to two external as observers. The Chairman of the who also sits on the Committee, have appointees, and a Management 37

accounting and financial backgrounds Committee is Greg Gent. Principal representative, being the Director | and are both Appointed Directors. activities of the SRC include Fonterra Milk Supply. monitoring the interface between The AFRC has significant roles in The current Chairman of the Working Fonterra and shareholders; reviewing Group is Mark Townshend. The (i) assisting the Board to ensure the the delivery of services to purpose of the MPWG is to assist the quality and integrity of financial shareholders, and terms and Board with the development of milk reports, conditions of supply; acting as an

pricing signals in co-ordination 2005 ANNUAL REPORT (ii) reviewing the risk and assurance interface for shareholders with with the development of the processes, and complaints against the Company and capital structure. (iii) oversight of Treasury operations liaising with the Milk Commissioner • Takeover Committee: A temporary and policies. Principal activities of in relation to complaints that cannot Committee of the Board was formed the AFRC include establishing be resolved. The SRC also provides during the year to monitor the and reviewing internal audit and a significant interface with Company’s offer for the shares of global assurance processes; the Shareholders’ Council on National Foods. This Committee was reviewing the internal control shareholder / supplier issues. chaired by Roger France and also framework, significant risks, • Fair Value Share Review Committee reviewed other acquisitions which exposures and mitigation (“FVS Committee”): The FVS were considered during the strategies; reviewing financial Committee is comprised of four reporting period. reporting practices and offering Directors. The Board Chairman and documents; review and oversight CEO may also attend ex-officio. CORPORATE GOVERNANCE – Continued

Remuneration of Directors its best estimate. The Board also uses and complements communication and The remuneration of Directors is shareholder meetings to update compliance with those policies. governed by the Constitution. The shareholders on the Company’s Within Management, the Ethics Directors’ Remuneration Committee performance, and strategic issues. programme is the responsibility of the (“DRC”), an independent, shareholder- Shareholders also receive information Fonterra Leadership Team and is elected committee, considers and relating to the Fair Value Share, annual administered by the Director of Human recommends for shareholder approval, and half-year financial results, and Resources who reports to the ARD the form and amount of remuneration elections of Directors and Shareholders’ Committee in relation to ethical matters. for Elected Directors. The Board is Councilors. As a listed issuer of debt The Director of Human Resources responsible for setting remuneration of securities, Fonterra also keeps the reports at least annually on Ethics issues Appointed Directors, but generally market informed of relevant material and is assisted in administering the follows the remuneration levels information through announcements Ethics programme by an Ethics approved for Elected Directors. The to NZX. Committee comprised of members of Board is authorised to approve special management including the General remuneration for a Director who is Counsel, Director of Global engaged to carry out work other than Shareholders’ Council Assurance and members of offshore as a Director of Fonterra or where a The Board has a significant and unique businesses and major business units Director is called upon to exercise relationship with the Shareholders’ of the Company. special skills for the benefit of Council, which is established under the the Company. Constitution. The Council is During the reporting period Fonterra did independent of the Board and not encounter any breaches of policy or Shareholder Relations and comprises 46 shareholders, representing its Code of Conduct that were material. Stakeholder Interests 25 different wards, who are elected by the shareholders. The Council’s The Board is particularly interested in Audit Independence Policy functions include reviewing the Board’s ensuring the co-operative nature of the statement of intentions for the The Board, primarily through the AFRC, Company is reflected in its dealings with performance and operations of the ensures that the external Auditor its supplying shareholders. Company, and commenting on reports appointed by the Company is Consequently, Fonterra has extensive from the Board on the Company. The independent. Fonterra operates a programmes for fostering and Board and Council share common rigorous selection process in order to enhancing relationships with its interests in shareholder issues, which are appoint its auditors and has a policy of supplying shareholders. generally addressed through the SRC, rotating its lead external audit partner in accordance with best practice. AFRC The Board and Management maintain MPWG, or similar mechanisms. approval is required for any activities the regular direct contact with shareholders The Board receives regular feedback Auditor undertakes for the Company through a significant number of from the Council, both at its regular other than those specified in their meetings held with shareholders meetings, and through regular meetings engagement as Auditor. In general, the throughout New Zealand. between the Chairs of the Board and AFRC will not approve the Auditor Shareholders are encouraged to attend the Council and the Chairs of their performing any potentially conflicting those meetings to engage with the respective Committees. To assist the tasks unless exceptional circumstances Directors and Management and to gain working relationship, the Board and exist and appropriate safeguards on a better understanding of the Fonterra Council have approved a written independence are put in place. business. This is supported by Fonterra protocol as the working interface between the Board, executive and Milk Supply (formerly Shareholder Governance Standards Services), which has a team of Field Shareholders’ Council. The Board recognises the need to Representatives who regularly meet with continue to keep its Governance shareholders to discuss supply and Ethics Framework and Standards under review to ensure they other issues. Stakeholder Interests are in line with developing best practice. 38 A call centre for shareholder comments, Fonterra’s Board is committed to the In so doing, the Board has considered | questions and complaints is operated to ethical conduct of the Company’s standards, guidelines, and principles ensure that shareholders’ concerns can business around the world. The published by a range of interested be addressed. Fonterra also maintains a Company has published The Way We parties in New Zealand and shareholder website “Fencepost” which Work – Fonterra’s Code of Business internationally. The work by New assists in day-to-day dealings with Conduct, which reinforces this Zealand Exchange Limited, as shareholders, as well as a corporate commitment. The Way We Work is incorporated in the NZX Listing Rules, based on Fonterra’s Values and and the publication of the Securities 2005 ANNUAL REPORT Fonterra website (www.fonterra.com) with general information on the Principles. It provides very clear policies Commission Principles and Guidelines Company which is accessible to the on the relationships that Fonterra has are of particular note, although these general public. with significant stakeholders such as are not mandatory or binding on employees, customers, shareholders, Fonterra. The objective of the Board is business partners and suppliers, and to structure its governance systems and Information Disclosure communities. The Code has a global disclosures to provide meaningful and The Board is committed to providing reach and is not limited to any particular effective governance that is appropriate information to its shareholders and country or community. The Way We in the particular context of Fonterra, other investors in a timely manner. The Work is not a substitute for the as a major co-operative based in Board regularly reviews the expected corporate policies of Fonterra. Rather it New Zealand. payout to suppliers, and communicates refers employees to the relevant policies BOARD OF DIRECTORS PICTURED FROM LEFT TO RIGHT Henry van der Heyden, Malcolm Bailey, Harry Bayliss, Greg Gent

HENRY VAN DER HEYDEN MALCOLM BAILEY Finance and Risk Committee and Fair Value BE (HONS) (LINCOLN) B AG (ECON) MASSEY Share Committee. Henry van der Heyden became Malcolm Bailey was elected to the His farming interests have centred on Chairman of Fonterra Co-operative Fonterra Board of Directors in May coastal Taranaki for more than 20 years, Group in September 2002 and is a 2004. He is a member of the starting with the purchase of a dairy founding Director of the co-operative. Shareholders Relations Committee and farm in Otakeho in 1981 after five years He has contributed to industry the External Relations Committee. He is sharemilking. Expansion of this holding governance for 13 years, as both a Fonterra’s representative on the has continued ever since and he now Director and Chairman and played a International Food and Agriculture Trade also has farming interests in South considerable role in the industry Policy Council. Waikato. He has a Bachelor of rationalisation that led to Fonterra’s Mr Bailey is a former National President Agricultural Science degree from establishment. He pioneered the of Federated Farmers, a former Fonterra Massey University. establishment of shareholder Shareholder Councillor, and has been a committees having a role in co-operative Special Agricultural Trade Envoy for the GREG GENT governance, a move which led to the New Zealand Government. He is Greg Gent has served the dairy industry establishment of Fonterra’s presently an External Monetary Policy as a director since 1993. He is Chairman Shareholders’ Council. Adviser to the Reserve Bank. of Fontera’s Shareholder Relations Mr van der Heyden currently serves on Committee and serves on the He has nine years experience as a Appointments, Remuneration and Fonterra’s Audit, Finance and Risk member of the Technology NZ Committee, and is Chairman of the Development Committee, the Trade Reference Group analysing research and Strategy Committee and the Milk Price 39 Appointments, Remuneration and development projects, and has served | Development Committee and External Working Group. He is also a Director of on the Animal Remedies and Pesticides FMG Insurance. Relations Group. He is also a Director of Boards, as well as a director of Embryo the NZX, Innovation Waikato Ltd, King St Technologies Ltd and Process He began his career working for the Bank Advertising and serves on Waikato Solutions Group. of New Zealand in 1972. After five years University’s School of Management he made the move into dairying, with Advisory Board. He is a Trustee of Asia: Mr Bailey farms 205 hectares near

700 cows on his farm at Ruawai, 2005 ANNUAL REPORT New Zealand. Feilding. He holds a Bachelor of Agricultural Economics degree from Northland. In 2002 Mr Gent completed He holds a Bachelor of Engineering Massey University. the Advanced Management Programme (Agr) with Honours from Lincoln at INSEAD, France. University and began his farming career sharemilking in the Putaruru/Tokoroa HARRY BAYLISS ROGER FRANCE B AGR SC (MASSEY) area, where he purchased a farm in BCOM, CA 1985. He is still on the property and has Harry Bayliss has been a dairy company Roger France joined the Board of Fonterra expanded the holding from its original director for 17 years. He has served as in January 2003. He spent the first eleven 80 hectares to 110 hectares. He milks Chairman of the New Zealand Dairy years of his professional career with a approximately 320 cows. He owns two Research Institute and as a director of PricewaterhouseCoopers predecessor firm, other dairy farms in the area and a dry Bonlac Foods in Australia, ViaLactia including five years in audit supervisory stock holding. Biosciences, Dairy Meats and LIC. He is and management positions in Sydney currently a member of Fonterra’s Audit, and London. BOARD OF DIRECTORS PICTURED FROM LEFT TO RIGHT Roger France, Graeme Hawkins, David Hoare, Ian Johnson

He spent 10 years as Chief Financial His business experience includes 13 years Mr Hoare serves on the Officer with two publicly listed with the Fletcher Group in a variety of Appointments, Remuneration and companies, Allied Farmers Co-operative strategic planning and financial roles, Development Committee. Limited and Freightways Holdings including an 18 month secondment to Limited, before returning to what was the Prime Minister’s Advisory Group. He IAN JOHNSON then Coopers & Lybrand as a partner in then worked for Dominion Breweries for BSC (HONS) the Corporate Finance division, eight years, becoming CEO in 1987. He Ian Johnson joined Fonterra’s Board of subsequently serving as the Managing has been a professional director for the Directors as an independent director on Partner in Auckland. past 12 years. October 1, 2004. He is a member of the Following the merger with Price Mr Hawkins has Bachelor of Science and Appointments, Remuneration and Waterhouse, he sat on the Management Commerce degrees and is an Associate Development Committee. Board of PricewaterhouseCoopers and Chartered Accountant. Mr Johnson is Chairman of Newcrest led its Corporate Value Consulting He is Chairman of Fonterra’s Audit, Mining Ltd, former Chairman of The practice in the Asia Pacific region for Finance and Risk Committee and serves Somerville Collection, a director of John three years before retiring from the firm on the Appointments, Rumuneration Holland Holdings and a member of The in June 2001. and Development Committee and the University of Sydney Remuneration He joined Air New Zealand’s Board in Fair Value Share Committee. Committee. He is a former director of October 2001, acting as Executive Director Leighton Holdings Ltd, Orogen Minerals until February 2002 and is now the DAVID HOARE Ltd and Email Ltd. airline’s Deputy Chairman and Chairman BEC FCPA 40 A professional director since 1997 and a

| of its Audit Committee. Mr France has David Hoare is Chairman of Principal Fellow of the Australian Institute of been Chairman of the private investment Global Investors Australia Ltd. From 1991 Company Directors, Mr Johnson is a company Tappenden Holdings since 1997, to 2000 he was Chairman of Telstra former geologist who worked for and is a member of the University of Corporation Ltd, the 50 per cent mining company CRA Ltd from 1970 Auckland Council. government owned telecommunications to 1996. carrier. Between 1971 and 1999 he was He serves on Fonterra’s Audit, Finance Managing Director and later Chairman of

2005 ANNUAL REPORT and Risk Committee and is Chairman of STUART NATTRASS Bankers Trust Australia Ltd. He is also the Fair Value Share Committee. B AG SC (HONS) (LINCOLN) Chairman of ASX Supervisory Review Ltd. Stuart Nattrass was elected to the He is a member of the Investment GRAEME HAWKINS Fonterra Board of Directors in June Banking Advisory Board of Credit Suisse BSC, BCOM, ACA 2003. He is a member of the Audit, First Boston in Australia. Graeme Hawkins is Chairman of Finance and Risk Committee. Watercare Services Ltd and a director of a He is a Government appointed Fellow of Mr Nattrass has been involved in number of other companies including the Senate in the University of Sydney, International Financial markets, principally Ballance Agri-Nutrients Co-operative Ltd, chairs the University’s Finance and Foreign Exchange risk management, for the Horizon Energy and Cavalier Corporation Remuneration Committees and is past 16 years. He was initially employed at Ltd. He is a former director of Bay Milk Pro-Chancellor. He is also Chairman the National Bank in Wellington and he Products Ltd and Northland Co-operative of the Australian Graduate School most recently held the position of Global Dairy Company Ltd. of Management. Head of Foreign Exchange Risk for Westpac based in Sydney. PICTURED FROM LEFT TO RIGHT Stuart Nattrass, Earl Rattray, Mark Townshend, Jim van der Poel, John Wilson

He has been involved in farming all his Mark has been farming for more than JOHN WILSON life, and his interests now include thirty years and is involved in four dairy B AG SC (MASSEY) ownership of a 420ha pastoral property farms in each of the North and South John Wilson was elected to the Fonterra near Geraldine. He also has a share in a Islands. He also has farming interests in Board of Directors in June 2003. He is 1,200 cow spray irrigated dairy farm both North & South America. currently serving on the Shareholder near Ashburton. Mark and wife Diane have four adult Relations Committee, the Milk Pricing Mr Nattrass has a Bachelor of tertiary educated children who are all Working Group and the Fair Value Agricultural Science with Honours from connected with agriculture. In 1997 Share Committee. Lincoln University. Mark and Diane were the inaugural He was the first Chairman of the national winners of the FMG AC Fonterra Shareholders’ Council and is EARL RATTRAY Cameron Excellence in Farming Award. the Chairman of SAITL. B AG (ECON) (MASSEY) Earl Rattray has been a dairy company JIM VAN DER POEL Mr Wilson is also a member of the director for 10 years. He is Chairman of Jim van der Poel has been a dairy Institute of Directors and holds a the Dairy Companies Association of company director since 1999 and was certificate in Company Direction. New Zealand and currently serves on elected to the Fonterra Board in 2002. Mr Wilson was awarded a Nuffield Fonterra’s Audit, Finance and Risk He presently serves on the Audit, Finance Scholarship in 2000. In 2003 he was Committee and its External Relations and Risk Committee, the Shareholder selected for the Fonterra Advanced Committee. Relations Committee and the Milk Price Development Programme. Working Group. Mr Rattray farms 150 hectares at He lives near Te Awamutu with his wife 41 Honikiwi near Otorohanga. Prior to dairy He is chairman of Dexcel and a director Belinda and their four children, and has | farming, he worked as an economist for of a number of private companies in built a dairy farming business that the New Zealand Meat and Wool Boards’ which he is a shareholder. He and his includes their farm in Te Awamutu and Economic Service in Wellington. He holds family live and farm at Ohaupo in the joint ownership in farms in Geraldine, a Bachelor’s degree in Agricultural Waikato but also have farming interests South Canterbury. Economics and is a member of the in the South Island. Mr van der Poel has Institute of Directors and the Institute of won a number of farming awards Mr Wilson has a Bachelor of Agricultural 2005 ANNUAL REPORT Primary Industry Management. including Sharemilker of the Year, The Science from Massey University. A.C. Cameron Award, Dairy Exporter MARK TOWNSHEND Primary Performer Award and a 2002 Mark Townshend has been a Director of Nuffield Scholarship studying Capital Fonterra since formation. He is Structures of Co-operatives. Chairman of the Milk Pricing Working Group and serves on the Appointments, Remuneration and Development Committee. Mark is the Chairman of eight farming companies and a Director of Liberty Genetics Ltd. FONTERRA LEADERSHIP TEAM

ANDREW FERRIER GUY COWAN He joined the New Zealand dairy industry CHIEF EXECUTIVE OFFICER CHIEF FINANCIAL OFFICER following a 27-year career with Unilever Andrew Ferrier has been Chief Executive Guy joined Fonterra as Chief Financial based in India, London and Europe, and Officer of the Fonterra Co-operative Officer in March 2005, following a 23- culminating in positions as Senior Vice Group since September 2003, bringing to year career with the Royal Dutch/Shell President Global Beverages, and his role a background in generating group of companies, which saw him hold Chairman of the Board for the $5 billion stronger performances from companies, a number of key finance positions in the Unilever beverages category. especially those with a mix of consumer group’s Latin American, European, Sanjay managed Unilever’s beverages and and commodity products operating in African, Australian and US culinary businesses in Central Asia, and global markets. operating units. for five years based in London, he was He has more than 20 years of experience Immediately prior to joining Fonterra, Guy responsible for the Pond’s, Vaseline, at the senior executive level with eleven was Vice President Finance and Chief Rexona and Axe brands. years as Chief Executive in both operating Financial Officer for Shell Oil company in Sanjay graduated with honours in and holding companies. In his career he the US, and a director of Shell Petroleum electrical engineering from the Indian has dealt continuously with free trade Incorporated, the holding company for Institute of Technology and in 1998 environments and heavily regulated Shell’s US interests. completed the Harvard University environments, experience now being Guy, who is British, was born in Advanced Management Programme. applied in Fonterra. Argentina and educated in Brazil and His leadership style is to strengthen England, graduating with an honours MAX PARKIN Fonterra at all levels, creating a culture of degree in engineering from the University DIRECTOR GROUP continuous improvement, pride in the of Sussex. He is qualified as a chartered MANUFACTURING (ACTING) business, and a strong desire to succeed. accountant in the UK and a certified As Acting Director Group Manufacturing, Andrew spent 16 years in the sugar public accountant in the USA, having Max has direct responsibility for all industry working in Canada, the United worked for major accounting firms in Fonterra ingredient manufacturing and States, the United Kingdom and Mexico. England, South America and the US, and logistic functions. His role also includes This experience culminated in Andrew is fluent in both Spanish and Portuguese. the manufacturing activities of joint becoming President and Chief Executive venture companies Bonlac, DairiConcepts Officer of Tate & Lyle North America JERRY SAVILLE and Dairy Partners Americas. Sugars Inc, a large division of Tate & Lyle DIRECTOR OF HUMAN RESOURCES After graduating from Massey University PLC. Prior to joining Fonterra he headed Jerry joined Fonterra in May 2004 with a BSc in Microbiology, Max spent 15 GSW Inc. in Toronto, Canada, a publicly following a two-year assignment with years at the New Zealand Dairy Research traded Canadian company selling Maxis Communications Bhd, Malaysia’s Institute working first on yield and loss branded consumer building and fastest-growing mobile communications measurement and then on environmental water products. company. He was Head of Organisational matters related to dairying. Andrew has a Bachelor of Business Development and played a wide-ranging Subsequently, he held a number of Administration from the University of role in building its HR capability. management positions within the industry, New Brunswick and a Master of Business Previously, Jerry spent 27 years with the including: General Manager Resources and Administration from Concordia University. Shell Oil Company, starting as a graduate Regional General Manager at Anchor trainee on the completion of his Master Products, the manufacturing group of New 42 GRAHAM STUART of Arts in Philosophy and Psychology at Zealand Dairy Group; Chief Executive of | GROUP DIRECTOR STRATEGY & GROWTH Oxford University. During his career with Southland Dairy Company (prior to its merger with Alpine); and three years as Graham’s experience in the New Zealand Shell, he held major HR roles in the General Manager of Kiwi Dairy Dairy Industry dates back to 1985 when business in the USA, Asia, Australia, Products Ltd. he started working for Mainland Europe and Africa. He has also held other Products. Since then he has held a senior positions including that of Head of Max was appointed Director Operations number of roles within the Dairy Industry Strategic Planning (UK), Retail Network when Fonterra was formed, and made including CEO of Mainland, Commercial Development Manager (Australia), and Acting Director Group Manufacturing in 2005 ANNUAL REPORT Director for New Zealand Milk, Group Vice President, Transformation (Europe). June 2005. He chairs the Fonterra General Manager Finance and Strategy In addition to his MA, Jerry holds a Business Continuity Council and is a for Kiwi Co-operative Dairies, Project Diploma in Industrial Relations and member of the Fonterra Food Director for the Fonterra Merger and completed the London Business School’s Assurance Council. Chief Financial Officer. Sloan programme with distinction. From 1995 to 1999 Graham left the Dairy During his years at Oxford he was an BOB MAJOR Industry and worked with Lion Nathan as IBM scholar. DIRECTOR FONTERRA INNOVATION Managing Director International Division, Bob has a career in the dairy industry General Manager Asia and Corporate SANJAY KHOSLA spanning more than 20 years. He has a Strategy Director. MANAGING DIRECTOR, FONTERRA BRANDS Masters of Science degree in Graham graduated from the University of Sanjay Khosla joined Fonterra Co- microbiology from Massey University, and Otago with a First Class Honours Degree operative Group in August 2004 and is joined the New Zealand Dairy Research in Commerce and holds a Master of Managing Director of its consumer dairy Institute in 1981, moving to the then Science degree from the Massachusetts products business, Fonterra Brands. New Zealand Dairy Board two years later. Institute of Technology. PICTURED BELOW 1 Andrew Ferrier, 2 Graham Stuart, 3 Guy Cowan, 4 Jerry Saville, 5 Sanjay Khosla, 6 Max Parkin, 7 Bob Major, 8 John Shaskey, 9 Barry Harris, 10 Barry O’Donnell, 11 Brenda Baldwin

Following senior management roles for He is a former CEO of Environment New Zealand Milk Products (NZMP) in the Waikato and of the South Waikato Middle East and China, he returned to District Council and worked as an New Zealand as General Manager economist in the Ministry of Natural Marketing, later becoming Global Resource Development for the Republic Marketing Director. of Kiribati. In 1999, he was appointed Group Director – Global Strategy for the New BARRY O’DONNELL Zealand Dairy Board, leading the project DIRECTOR SHAREHOLDER SERVICES which resulted in the formation of a joint (NOW FONTERRA MILK SUPPLY) 1 2 RETIRING DECEMBER 2005. venture with Nestle and Dairy Partners America. With the formation of Fonterra Barry O’Donnell’s career in the dairy in 2001, he became Director Global industry began in 1985 when he was Marketing and Strategy, subsequently appointed Company Secretary of the taking up this role with NZMP. With the New Zealand Dairy Group. From there, he restructure of Fonterra in 2002, and the took on an expanded role as Group incorporation of NZMP into the co- General Manager Corporate. Barry held operative, Bob was appointed Director – this position until the dairy industry Marketing and Innovation, before taking merger in 2001 when he left New up his present position in June 2005. Zealand Dairy Group and joined Tatua 3 4 Co-operative Dairy Company as Company JOHN SHASKEY Secretary. He joined Fonterra in December MANAGING DIRECTOR 2002 when he was appointed Director of FONTERRA INGREDIENTS Shareholder Services. John Shaskey began his career with the Barry has a Bachelor of Commerce from New Zealand Dairy Board in 1977 as a Victoria University. He spent two years Transport Coordinator. Over the following with Deloitte Touche Tohmatsu in few years he held several New Zealand- Wellington, followed by three years based based operational and sales positions. in their London operation. In that time he 5 6 In 1985, he moved to Mexico as a was seconded to one of their major clients regional representative for the Dairy and then spent several years in the Middle Board, the first of several overseas East oil industry in a number of assignments, including CEO of the Middle financial roles. Eastern region and Regional Managing On his return to New Zealand he Director Asia. spent four years with a TNL Group In 2001 John returned to New Zealand as subsidiary as Company Secretary and Group Managing Director of Global Financial Controller. Operations for the Dairy Board, and when Fonterra was formed he was appointed BRENDA BALDWIN 7 8 Director Sales and Operations Planning. In DIRECTOR CORPORATE COMMUNICATIONS 43 November 2003, John assumed a new | role as Director, Global Sales Network, Brenda Baldwin who heads the responsible for Fonterra’s offices communications team has more than 25 worldwide, before becoming Managing years of experience in public relations in Director Fonterra Ingredients in New Zealand and the Asia Pacific region. June 2005. This includes more than 10 years of dairy industry experience during the period of BARRY HARRIS industry rationalisation which led to the 2005 ANNUAL REPORT DIRECTOR FONTERRA MILK SUPPLY merger that created Fonterra. 9 10 (FORMERLY SHAREHOLDER SERVICES) She is Chairman and a founding partner Barry Harris joined the Fonterra Co- of Baldwin Boyle Group and a Fellow of operative Group in June as Director the Public Relations Institute of New Fonterra Milk Supply to replace Barry Zealand. Fonterra’s communications were O’Donnell on his retirement at the end outsourced at the end of 2002. of 2005. The former CEO of the Greater Wellington Regional Council, Barry has a background focused on issues of sustainability, particularly in the agricultural sector, an 11 area that is of increasing importance to Fonterra. PATHS TO LEAD IN DAIRY

44 | 2005 ANNUAL REPORT FINANCIAL STATEMENTS

The Directors hereby approve the financial statements for the year ended 31 May 2005. For and on behalf of the Board of Directors who authorised the issue of these financial statements on 19 July 2005:

HENRY VAN DER HEYDEN GRAEME HAWKINS CHAIRMAN DIRECTOR 19 July 2005 19 July 2005

45 | 2005 ANNUAL REPORT

THE FINANCIAL STATEMENTS COMPRISE:

Statements of Financial Performance 46 Statement of Significant Accounting Policies 50 Statements of Movements in Equity 47 Notes to the Financial Statements 56 Statements of Financial Position 48 Auditors’ Report 81 Statements of Cash Flows 49 Statutory Information 82 Statements of Financial Performance For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

Year ended Year ended Year ended Year ended Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

Operating revenue 1 12,323 11,830 5,342 5,158

Payout to suppliers (5,329) (5,104) (5,329) (5,104) Inventory increase 384 110 – – Other costs of goods sold 2 (5,217) (4,765) (13) (28) Total costs of goods sold (10,162) (9,759) (5,342) (5,132)

Operating expenses 2 (1,648) (1,779) 227 (8) Interest expense 2 (269) (250) (247) (223) Other expenses (1,917) (2,029) (20) (231)

Operating surplus / (deficit) before taxation 244 42 (20) (205) Taxation (expense) / credit 3 (25) (26) 175 154 Net surplus / (deficit) 219 16 155 (51)

Net surplus / (deficit) comprises: Parent interests 191 7 155 (51) Minority interests 28 9 – – Net surplus / (deficit) 219 16 155 (51)

46 | 2005 ANNUAL REPORT

The accompanying notes form part of these financial statements. Statements of Movements in Equity For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

Year ended Year ended Year ended Year ended Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

Net surplus / (deficit) comprising: Parent interests 5a 191 7 155 (51) Minority interests 5c 28 9 – – Foreign currency translation reserve movement: Parent interests 5b (36) (58) – – Minority interests 5c (12) 2 – – Total recognised revenues and expenses 171 (40) 155 (51)

Co-operative shares issued 4 200 395 200 395 Peak notes issued 4 51 64 51 64 Supply redemption rights issued 4 244 93 244 93 Total contributions from owners 495 552 495 552

Co-operative shares surrendered 4 (404) (205) (404) (205) Peak notes surrendered 4 (74) (68) (74) (68) Supply redemption rights surrendered 4 (57) (130) (57) (130) Total distributions to owners (535) (403) (535) (403)

Other movements in minority interests 5c (15) 21 – –

Movements in equity for the year 116 130 115 98 Equity at the beginning of the year 4,795 4,665 4,613 4,515 Equity at the end of the year 4,911 4,795 4,728 4,613

Equity at the end of the year comprises: Parent interests 4,728 4,613 4,728 4,613 Minority interests 5c 183 182 – – Equity at the end of the year 4,911 4,795 4,728 4,613

47 | 2005 ANNUAL REPORT

The accompanying notes form part of these financial statements. Statements of Financial Position As at 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

As at As at As at As at Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

Cash balances 116 127 1 26 Receivables and prepayments 6 2,271 1,813 3,533 5,318 Inventories 7 3,245 2,861 – – Taxation receivable 38 31 195 199 Other current assets 34 82 1 3 Total current assets 5,704 4,914 3,730 5,546

Property, plant and equipment 8 4,297 4,196 41 35 Investments 9 331 443 7,309 5,425 Intangibles 11 1,469 1,546 – – Other non-current assets 11 13 – 2 Total non-current assets 6,108 6,198 7,350 5,462 Total assets 11,812 11,112 11,080 11,008

Bank overdrafts 79 33 8 11 Owing to suppliers 982 707 1,015 736 Payables and accruals 12 983 984 1,106 1,867 Provisions 13 88 128 23 58 Current borrowings 14 1,480 1,061 1,374 913 Taxation payable 29 43 – – Other current liabilities 52 88 51 86 Total current liabilities 3,693 3,044 3,577 3,671

Provisions 13 62 46 53 36 Term borrowings 15 2,418 2,704 2,090 2,308 Deferred taxation 16 7 53 (81) (90) Capital notes 17 483 370 483 370 Other non-current liabilities 238 100 230 100 Total non-current liabilities 3,208 3,273 2,775 2,724 Total liabilities 6,901 6,317 6,352 6,395 Net assets 4,911 4,795 4,728 4,613

Co-operative shares 4 3,334 3,538 3,334 3,538 Peak notes 4 1,137 1,160 1,137 1,160 48 Supply redemption rights 4 338 151 338 151 | Retained earnings 5a 166 74 (81) (236) Foreign currency translation reserve 5b (247) (310) – – Minority interests 5c 183 182 – – Equity 4,911 4,795 4,728 4,613 2005 ANNUAL REPORT

The accompanying notes form part of these financial statements. Statements of Cash Flows For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

Year ended Year ended Year ended Year ended Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

Cash flows from operating activities Cash was provided from: Receipts from customers 12,044 11,917 5,291 4,999 Interest received 9 11 20 18 Dividends received 30 25 – – Taxation received 5 20 4 8 Cash was applied to: Payments to creditors and employees (6,168) (6,019) (262) (133) Payments to suppliers (5,322) (4,763) (5,180) (4,762) Taxation paid (108) (87) – – Interest paid (262) (325) (221) (316) Net cash flows from operating activities 18 228 779 (348) (186)

Cash flows from investing activities Cash was provided from: Proceeds from disposal of property, plant and equipment 59 54 8 15 Proceeds from sale of subsidiaries 19 (b) 64 – – – Proceeds from sale of associates 5 – – – Proceeds from sale of investments 40 1 – 3 Loans to external entities – 19 – – Cash acquired on acquisition of subsidiary 19 (a) – 39 – – Cash was applied to: Acquisition of property, plant and equipment (620) (515) (27) (11) Acquisition of other intangibles (6) – – – Net loans to subsidiaries – – (131) 604 Purchase of minority interests (105) – – – Acquisition of associates / investments (78) – (8) – Acquisition of subsidiaries (5) – – – Net cash flows from investing activities (646) (402) (158) 611

Cash flows from financing activities Cash was provided from: Increase in borrowings 6,033 5,083 6,236 4,937 Issue of co-operative shares 265 245 265 245 49

Issue of peak notes 24 17 24 17 | Repayment of deferred share receivable – 1 – 1 Cash was applied to: Repayment of borrowings (5,856) (5,579) (5,958) (5,535) Repurchase of capital notes (83) (39) (83) (39) Dividends paid to minority interests (17) (31) – –

Net cash flows from financing activities 366 (303) 484 (374) 2005 ANNUAL REPORT

Net (decrease) / increase in cash held (52) 74 (22) 51 Opening cash balances 94 20 15 (36) Effect of exchange rate changes on cash flows (5) – – – Closing cash balances 37 94 (7) 15 Reconciliation of closing cash balances to the statement of financial position: Cash balances 116 127 1 26 Bank overdrafts (79) (33) (8) (11) Closing cash balances 37 94 (7) 15

The accompanying notes form part of these financial statements. Statement of Significant Accounting Policies For the year ended 31 May 2005 Fonterra Co-operative Group Limited

(a) Basis of preparation Fonterra Co-operative Group Limited (the “Company” or “Parent” or “Fonterra”) is a co-operative company domiciled in New Zealand, registered under the Companies Act 1993, the Co-operatives Companies Act 1996, and the Dairy Industry Restructuring Act 2001. Fonterra is an issuer for the purpose of the Financial Reporting Act 1993 and its financial statements comply with that Act. The reporting currency used in the preparation of these financial statements is New Zealand dollars. Financial statements for Fonterra and consolidated Group financial statements are presented. The financial statements comprise statements of the following: financial performance; movements in equity; financial position; cash flows; significant accounting policies; as well as the notes to these statements contained on pages 56 to 80. The financial statements have been prepared in accordance with generally accepted accounting practice (“GAAP”) in New Zealand. Where no financial reporting standard or statement of standard accounting practice exists in New Zealand in relation to a particular issue, the accounting policies and disclosures adopted have been determined having regard to sources of Authoritative Support. The financial statements are prepared on the basis of historical cost except that derivative financial instruments that are not designated as hedges are stated at market value and investments in subsidiaries are stated at Fonterra’s share of net assets. The cost of certain assets and liabilities is based on their fair value at the date of the formation of the Company.

(b) Basis of consolidation The consolidated financial statements comprise the Company, its subsidiaries (the “Group”) and the Group’s interest in associates, joint ventures and partnerships. Intra-Group transactions are eliminated in preparing the consolidated financial statements.

Subsidiaries Subsidiaries are entities that are controlled, either directly or indirectly, by the Parent. Subsidiaries are included in the consolidated financial statements using the purchase method of consolidation.

Associates Associates are entities in which the Parent, either directly or indirectly, has a significant but not controlling interest. The consolidated financial statements include the Group’s share of the net surplus / (deficit) of associates on an equity accounted basis.

Acquisition or disposal during the year Where an entity becomes or ceases to be a part of the Group during the year, the results of the entity are included in the consolidated results from the effective date that the entity became a subsidiary or an associate or until the date it ceased to be a subsidiary or associate.

Goodwill and discount arising on acquisition 50 Fair values are assigned to the identifiable assets and liabilities of subsidiaries and associates of the Group at the date they are | acquired. Where the fair value of the identifiable net assets acquired in the purchase of a subsidiary or an associate is less than the purchase price paid, the difference is treated as goodwill and is written off on a straight line basis, over the period of expected benefit, for up to 20 years following the date of acquisition. Where the fair value of the identifiable net assets acquired in the purchase of a subsidiary or an associate exceeds the purchase price paid, the difference is treated as discount on acquisition and is applied to reduce the fair value of acquired non-monetary assets. 2005 ANNUAL REPORT Statement of Significant Accounting Policies For the year ended 31 May 2005 Fonterra Co-operative Group Limited

(c) Foreign currency Exchange differences Short-term transactions covered by forward exchange contracts are translated at the exchange rates specified in those contracts. Other foreign currency transactions are translated to New Zealand currency at the exchange rates ruling at the dates of the transactions. Monetary assets and liabilities in foreign currencies at balance date covered by forward exchange contracts are translated at the exchange rates specified in those contracts. Monetary assets and liabilities in foreign currencies at balance date not covered by forward exchange contracts are translated at the exchange rates ruling at that date. Exchange differences arising on the translation of monetary assets and liabilities in foreign currencies are recognised in the statement of financial performance except as detailed below. If a foreign currency liability is designated as a hedge of a foreign non-monetary asset (or vice versa), both the asset and the liability are translated at the exchange rate ruling at balance date. Exchange movements are taken to the foreign currency translation reserve except where the exchange movements on the liability exceed that of the asset.

Translation of the financial statements of foreign operations The assets and liabilities of overseas operations, being independent foreign operations, are translated at the exchange rates ruling at balance date. The revenues and expenses of these operations are translated at rates approximating the exchange rates ruling at the dates of the transactions. Exchange differences arising on the translation of the financial statements of independent foreign operations are recognised directly in the foreign currency translation reserve. Derivative financial instruments that are designated as hedges of the net investment in independent foreign operations are translated at the exchange rates ruling at balance date. Exchange differences arising on the translation of such derivative financial instruments are recognised directly in the foreign currency translation reserve to the extent that they offset the exchange differences arising on the translation of the financial statements of the independent foreign operations to which the designated hedge relates.

(d) Derivative financial instruments The Group uses derivative financial instruments within predetermined policies and limits in order to manage exposure to fluctuations in foreign currency exchange rates and interest rates. Derivative financial instruments that are designated as hedges of specific foreign exchange, interest rate risks or economic exposures are recognised on the same basis as the underlying hedged items. Where a hedge of an anticipated purchase or sale transaction is undertaken, the exchange difference on the hedging transaction up to the date of the purchase or sale transaction, and any costs associated with the hedge transaction to that date, are deferred and included in the measurement of the purchase or sale transaction. Derivative financial instruments that do not constitute hedges are stated at market value and any resultant gain or loss is recognised in the statement of financial performance. Where a derivative financial instrument, which is a hedge of an anticipated transaction, is terminated early but the anticipated transaction is still expected to occur, the deferred gain or loss that arose prior to termination continues to be deferred and is recognised as part of the transaction when it occurs. If the transaction is no longer expected to occur, the deferred gain or loss 51 | is recognised in the statement of financial performance immediately. The Group does not engage in speculative transactions or hold derivative financial instruments for trading purposes. 2005 ANNUAL REPORT Statement of Significant Accounting Policies For the year ended 31 May 2005 Fonterra Co-operative Group Limited

(e) Investments Investments other than investments in associates and investments in subsidiaries are stated at cost. In the Parent’s financial statements investments in subsidiaries are stated at Fonterra’s share of net assets and associates are stated at cost. Changes in value are recognised in the statement of financial performance.

(f) Identifiable intangible assets

Brands and other identifiable intangible assets purchased The fair value of brands and other identifiable intangible assets purchased by the Group are recognised where the intangible asset is controlled through custody or legal rights and could be sold separately from the rest of the business. Where such intangible assets are regarded as having limited useful lives their value is amortised over those estimated useful lives. Where such intangible assets are regarded as having indefinite useful lives, they are not amortised. However, impairment reviews are carried out on an annual basis to ensure that such intangible assets are not carried at amounts above their recoverable amounts. Any amortisation or impairment write-downs are recognised in the statement of financial performance.

Research and development expenditure All research expenditure is recognised in the statement of financial performance as incurred. Significant development expenditure is recognised as an asset when it can be demonstrated that the commercial production of the material or product, or use of the process, will commence. Development expenditure recognised as an asset is stated at cost and amortised in the statement of financial performance over the period of expected benefits on a straight-line basis, not exceeding five years. Amortisation begins at the time that commercial production or use of the process commences. All other development expenditure is recognised in the statement of financial performance as incurred.

(g) Property, plant and equipment

Owned assets Property, plant and equipment is stated at cost and depreciated in accordance with its estimated useful life as outlined below. Cost includes the purchase consideration and those costs directly attributable to bringing the asset to the location and condition necessary for its intended use. Costs cease to be capitalised when substantially all the activities necessary to bring an asset to the location and condition for its intended use are complete.

Depreciation Depreciation is calculated on a straight-line basis to allocate the cost of the asset, less any residual value, over its estimated useful life. The range of estimated useful lives for each class of property, plant and equipment is as follows: Land Indefinite 52 Buildings 25 – 50 years

| Plant, vehicles and equipment 3 – 30 years

Finance leases Assets under finance leases are recognised as non-current assets in the statement of financial position. Leased assets are recognised initially at their fair value, or if lower, at the present value of the minimum lease payments. A corresponding liability is established and each lease payment allocated between the liability and interest expense. Leased assets are depreciated on the same basis as equivalent property, plant and equipment. 2005 ANNUAL REPORT Statement of Significant Accounting Policies For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Operating leases Leases that are not finance leases are classified as operating leases. Operating lease payments are recognised as an expense on a basis representative of the pattern of benefits.

(h) Inventories Inventories are stated at the lower of cost and net realisable value. The cost of dairy product manufactured from milk suppliers in New Zealand is established by estimating an arm’s length cost for raw milk, being the price that could be paid by a hypothetical efficient competitor based on forecasted hedged selling prices while still making an adequate return on capital. In the case of manufactured inventories and work in progress, cost includes all direct costs plus that portion of the fixed and variable production overhead incurred in putting inventories into their present location and condition.

(i) Receivables Receivables are stated at estimated net realisable value.

(j) Impairment If the estimated recoverable amount of an asset is less than its carrying amount, the asset is written down to its estimated recoverable amount and an impairment loss is recognised in the statement of financial performance. Where an impairment is subsequently recovered the reinstatement of the previous impairment is recognised through the statement of financial performance.

(k) Provisions Provisions are recognised only in those circumstances where the Group has a present obligation as a result of a past event.

(l) Revenue recognition Sales revenue includes revenue earned net of returns, discounts and allowances from the sale of inventory items. Sales revenue is recognised when the significant risks and rewards of ownership of the inventory items have passed to the buyer.

(m) Payout to Suppliers Payout to Suppliers is the total available after retentions for payout to farmers for the milk they supply to the Group. Premiums for speciality milks, such as winter milk and colostrum, are included within other cost of goods sold.

(n) Taxation Income tax expense is recognised on the operating surplus / (deficit) before taxation, adjusted for permanent differences between taxable and accounting income. Deferred taxation is calculated using the comprehensive basis under the liability 53

method. This method involves recognising the tax effect of all timing differences between accounting and taxable income as a | deferred taxation asset or liability in the statement of financial position. The deferred taxation asset or liability is stated at the income tax rates prevailing at balance date. Deferred taxation assets are not recognised unless realisation of the asset is virtually certain. Deferred taxation assets and liabilities are not offset if they arise in different tax jurisdictions. 2005 ANNUAL REPORT Statement of Significant Accounting Policies For the year ended 31 May 2005 Fonterra Co-operative Group Limited

(o) Cash and cash equivalents For the purpose of the statement of cash flows, cash comprises cash balances (net of bank overdrafts) and demand deposits. Cash excludes borrowings at call that are not used as part of the Group’s day-to-day cash management.

(p) Comparative figures Where a change in the presentational format of the financial statements has been made during the period, comparative figures have been restated accordingly.

(q) Changes in accounting policy There have been no changes in accounting policies. Uniform accounting policies have been applied throughout the Group and on a basis consistent with the prior period.

(r) Adoption of New Zealand International Financial Reporting Standards (“IFRS”) The New Zealand Accounting Standards Review Board (“ASRB”) requires the adoption of IFRS for application to reporting periods beginning on or after 1 January 2007, with early adoption permitted for reporting periods beginning on or after 1 January 2005. Fonterra has elected not to adopt IFRS in 2005 or 2006. A discussion on how Fonterra is managing the transition to New Zealand IFRS and a narrative explanation of the key differences in accounting policies that are expected to arise from adopting New Zealand IFRS is set out below. In preparation for adoption of IFRS, Fonterra has formed a project team and sought independent external advice. The project team is led by senior finance personnel and reports on a regular basis to the Audit, Finance and Risk Committee (“AFRC”), a sub-committee of the Board. An initial assessment has been performed to determine the potential differences between the current key accounting policies of Fonterra and IFRS and is set out below. It should not be regarded as a complete list of changes in accounting policies that will result from the transition to IFRS, as some decisions have not yet been made where choices of accounting policies are available. In addition, IFRS and related interpretation may change between the issue date of these financial statements and the date that the IFRS opening balance sheet is prepared 1 June 2006. The regulatory bodies that promulgate New Zealand GAAP and IFRS have some significant ongoing projects that could affect the differences set out below and the impact of these variances may vary materially. The potential material differences between the current key accounting policies of Fonterra and IFRS identified to date are: Reporting of Equity: NZ IAS 32 Financial Instruments: Disclosure and Presentation and NZ IAS 39 Financial Instruments: Recognition and Measurement requires, inter alia, Fonterra’s shares to be classified as liabilities and carried at fair value with changes in fair value recognised in the statement of financial performance. Application of these standards in this manner would clearly produce an anomalous result in the presentation of the Group’s statement of financial position and accordingly the matter has been referred to the International Financial Reporting Interpretations Committee (“IFRIC”) which, in turn, referred it 54 to the International Accounting Standards Board (“IASB”). Members of the IASB have noted that the current IFRS produces an | unsatisfactory result in Fonterra’s circumstances and the IASB has included a project on its agenda to specifically consider whether instruments puttable at fair value, such as Fonterra’s fair value shares, should be classified as equity. Functional Currency: NZ IAS 21: The Effects of Changes in Foreign Exchange Rates, requires entities to record all transactions in their functional currency. Functional currency is the currency of the primary economic environment in which an entity operates. A foreign currency is a currency other than the entity’s functional currency. Fonterra’s functional currency may be either USD or NZD. Determining the functional currency of Fonterra has a pervasive flow-on effect on each of Fonterra’s 2005 ANNUAL REPORT subsidiaries’ determination of functional currency. A final decision is yet to be made on the functional currency of Fonterra. Statement of Significant Accounting Policies For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Financial Instruments and Hedge Accounting: NZ IAS 39: Financial Instruments Recognition and Measurement, requires all derivative and hedging instruments to be recorded at fair value in the statement of financial position with the related changes in fair value being recorded either to equity or income depending on whether the instruments meet the strict NZ IAS 39 hedging criteria. Fonterra currently uses both foreign exchange contracts (options and forwards) to hedge forecast cash flows, and cross currency and interest rate swaps to hedge borrowings. If such instruments meet the strict NZ IAS 39 hedge criteria, changes in fair value of those instruments will be recorded directly in equity until the hedged transaction occurs, except to the extent of ineffectiveness of the instruments, which will be recorded in the statement of financial performance. If the instruments do not qualify as cash flow hedges, the entire change in the fair value of the instrument will be recorded in the statement of financial performance. Income Tax: NZ IAS 12: Income Taxes requires an entity to calculate a tax statement of financial position and to compare the carrying values to its accounting statement of financial position. Differences between the two statements of financial position are temporary differences on which deferred tax must be recognised (with some exceptions). This is different to current New Zealand accounting standards and will result in a deferred tax liability larger than that currently recorded in the statement of financial position of the Group (primarily as a result of recognition of deferred tax on brands). Business Combinations: NZ IFRS 3: Business Combinations is required to be followed for all business combinations entered into from the date of the opening balance sheet 1 June 2006. Under this standard all business combinations must be recognised using purchase accounting and goodwill will no longer be amortised (instead goodwill will be subject to an annual impairment test within the constraints of NZ IAS 36 Impairment of Assets). Because of the available exemptions under NZ IFRS 1 First-time Adoption of New Zealand Equivalents to International Financial Reporting Standards, Fonterra will have the option but not the requirement to restate past business combinations in accordance with these new requirements. Fonterra has not yet made a decision on whether it will restate past business combinations. Fonterra is still investigating a number of options under IFRS and has made no final decisions. Consequently, Fonterra has not been able to reliably quantify the impacts of IFRS on the financial statements of Fonterra and the Group.

55 | 2005 ANNUAL REPORT Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

Year ended Year ended Year ended Year ended Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

1. Operating revenue Operating revenue comprises: Sales 11,952 11,760 5,103 4,944 Dividends received 21 15 1 – Interest received 9 11 227 214 Share of net surplus / (deficit) of associates, after taxation 10 22 (6) – – Gain on disposal of investments 243 – – – Gain on disposal of property, plant & equipment 18 – 7 – Other operating revenue 58 50 4 – Total Operating revenue 12,323 11,830 5,342 5,158

2. Other cost of goods sold and operating expenses Other cost of goods sold and operating expenses include: Amortisation of goodwill on consolidation 11 14 12 – – Amortisation of brands 11 1 3 – – Amortisation of other intangible assets 11 7 10 – – Audit fees – Principal auditor 4 3 2 2 Other assurance fees – Principal auditor 2 2 1 1 Other services – Principal auditor 1 1 – 1 Bad and doubtful debts: Written off 5 – – – Increase in provision for doubtful debts – 15 – – Brand impairment 11 32 90 – – Brand impairment reinstatement 11 (15) (90) – – Loss on disposal of property, plant & equipment 4 9 – 1 Impairment – property, plant & equipment 6 3 – – Depreciation: Buildings 50 64 1 – 56 Plant, vehicles and equipment 398 377 19 27 | Directors’ remuneration: Fees 1 1 1 1 Donation and grants 1 1 – – Operating lease expense 61 54 5 3 Research costs 44 32 1 –

2005 ANNUAL REPORT Revaluation of investments in subsidiaries to net asset backing – – (528) (301) New Zealand Dairy Board share price arbitration settlement – 3 – 3 Group share of uplift in Bonlac Foods Limited’s fair value of assets 19 (a) – (18) – – Interest expense includes: Finance leases 14 11 – – Borrowings 255 239 247 223 Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

Year ended Year ended Year ended Year ended Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

3. Taxation Operating surplus / (deficit) before taxation 244 42 (20) (205) Prima facie taxation expense / (credit) at 33% 80 14 (7) (68) Add / (deduct) taxation effect of: Non-deductible / (non-assessable) items: Dividends received (7) (5) – – Capital gain on sale (79) – – – Amortisation of intangible assets 7 8 – – Brand impairment 11 30 – – Brand impairment reinstatement (5) (30) – – NZDB share arbitration – 1 – 1 Share of net surplus and deficits of associates after taxation (7) 2 – – Non-claimable tax credits 3 3 – – Other 19 5 (18) (5) Losses of overseas subsidiaries not recognised 6 35 – – Revaluation of investments in subsidiaries to net asset backing – – (174) (100) Controlled Foreign Company and Foreign Investment Fund regime adjustments 12 10 – – Recognition of tax losses (3) – 12 – Under / (over) provision prior year 8 (32) 12 18 Less tax on foreign income due to different tax rate (20) (15) – – Taxation expense / (credit) 25 26 (175) (154) Taxation expense / (credit) comprises: Current taxation 71 80 (184) (206) Deferred taxation 16 (46) (54) 9 52 25 26 (175) (154) Imputation credits Opening balance 31 39 Tax payments net of refund (4) (8) Attached to dividends received – – Closing balance 27 31 The imputation credits are available to the 57 shareholders of the Parent company: | Through the Parent company 27 31 Through subsidiaries 11 11 38 42 Dividend withholding payment credits The dividend withholding payment credits are available to the shareholders of the Parent company: 2005 ANNUAL REPORT Through the Parent company – – Through subsidiaries 1 1 1 1 Tax Losses Unrecognised tax losses available for set off against future assessable income: Tax losses 156 157 Tax saving thereon 47 53

The ability to utilise these tax losses depends on the generation of sufficient assessable income in the respective tax jurisdictions. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Parent and Consolidated

As at 31 May 2005 As at 31 May 2004

Number 000’s Value $M Number 000’s Value $M

4. Capital Co-operative shares: Opening balance 1,199,859 3,538 1,143,611 3,348 End of season (surrenders) / issues prior year (146) (1) 2,720 11 Issued 4,858 23 6,931 30 Surrendered (25,907) (122) (16,615) (72) End of season issues current year 39,729 186 90,757 397 End of season surrenders current year (59,959) (281) (27,545) (121) Peak notes compromise agreement ––– (12) Supply redemption rights price differential – (9) – (43) Closing balance 1,158,434 3,334 1,199,859 3,538

Peak notes: Opening balance 38,684 1,160 38,804 1,164 End of season (surrenders) / issues prior year (6) – –– Issued 136 4 211 6 Surrendered (1,485) (44) (1,119) (34) Peak notes compromise agreement ––408 12 End of season issues current year 1,574 47 1,523 46 End of season surrenders current year (1,015) (30) (1,143) (34) Closing balance (fully paid) 37,888 1,137 38,684 1,160

Supply redemption rights: Opening balance 38,306 151 52,998 188 End of season (surrenders) / issues prior year (34) – –– Issued 289 1 202 1 Surrendered (2,682) (10) (2,688) (9) End of season issues current year 51,719 243 21,150 92 End of season surrenders current year (11,756) (47) (33,356) (121) Closing balance (fully paid) 75,842 338 38,306 151

Co-operative shares Each shareholder supplying milk to the Company in a season is required to hold one co-operative share (“share”) for each 58 kilogram of milksolids obtainable from milk supplied to the Company by that shareholder in that season. | Shares are issued and surrendered at fair value. Fair value is determined on an annual basis for each season by the Board with the advice of an independent valuer. Fair value for the 2005/06 season has been set by the Board, after receiving Standard & Poor’s estimated fair value range, at $5.44 per share (2004/05 season: $4.69 per share). If a shareholder increases supply during a season and they do not hold sufficient shares to cover that increased production, they are required to purchase additional shares. Additional shares are paid for by: 2005 ANNUAL REPORT • the automatic surrender of supply redemption rights that are held; • cash; • redeeming any excess peak notes held; or • any combination of the above. The Company also has the option (not exercised to date) to allow additional shares to be paid for by redeeming any capital notes held by the shareholder. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

4. Capital (continued) If a shareholder decreases supply and therefore holds more shares than they are required to hold they must surrender those excess shares. The Company pays the surrender value: • at the option of the shareholder, by the issue of supply redemption rights; and / or • by the issue of capital notes. The Company also has the option (not exercised to date) to pay the surrender value by the payment of cash or, in special circumstances, by the issue of redeemable preference shares. Share changes required by shareholder increases in supply for the 2004/05 season are reflected in the capital set out above as at 31 May 2005. Rights attaching to the shares include: • voting rights on a poll or postal ballot of one vote per 1,000 kilograms of milksolids obtainable from milk supplied to the Company by a dairy farm during the season preceding that in which a poll or postal ballot is taken; • rights to a share in any dividends; and • rights to share in any surplus on liquidation of the Company. At 31 May 2005 $1 million is recognised as a deferred share receivable in the statement of financial position in relation to the total shares on issue (31 May 2004: $2 million).

Peak notes Each shareholder supplying milk to the Company in a season is required to hold a number of peak notes for the season as determined by the Board at the commencement of the season. Peak notes are issued based on each shareholder’s milk supply profile during the season. Peak notes are issued at $30 each. Peak notes are paid for by: • cash; • redeeming any capital notes held; or • a combination of the above. If a shareholder holds more peak notes than they are required to hold, that shareholder may choose to either: • hold the excess peak notes to use in the future; or • surrender the peak notes by giving notice to the Company. Where the peak notes are surrendered the Company pays the surrender value: • by the issue of capital notes; or • by the payment of cash. Peak notes have no voting rights, no dividend rights, and no rights to share in any surplus on liquidation of the Company.

Supply redemption rights Where a shareholder holds more shares than required in a season (based on actual supply of milk by that shareholder) the 59 | Company shall require that shareholder to surrender those excess shares. Supply redemption rights are issued to shareholders who elect to be issued with them in exchange for shares that are being surrendered. A supply redemption right gives its holder the right to either: • exchange each supply redemption right held for one co-operative share at no cost when further shares are required due to increased production (irrespective of the value of the supply redemption right); or • at any time surrender the supply redemption right at issue price. 2005 ANNUAL REPORT Supply redemption rights have no voting rights and no dividend rights. On liquidation each supply redemption right becomes due to be redeemed for an amount equal to its issue price, which will be paid after all other obligations of the Company have been met, but before distribution of any surplus to holders of shares.

Capital structure changes On 5 May 2005 shareholders voted in favour of a change to the current capital structure of the Group. Peak notes will be replaced with a capacity charge, and supply redemption rights will be removed. Fonterra will implement the new capital structure with effect from 1 June 2006. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

Year ended Year ended Year ended Year ended 31 May 2005 31 May 2004 31 May 2005 31 May 2004

5. (a) Retained earnings Opening balance 74 45 (236) (185) Current year net surplus / (deficit) 191 7 155 (51) Transfer from foreign currency translation reserve (99) 22 – – Closing balance 166 74 (81) (236)

5. (b) Foreign currency translation reserve Opening balance (310) (230) – – Difference arising on translation of financial statements of independent foreign operations (36) (58) – – Transfer to retained earnings 99 (22) – – Closing balance (247) (310) – –

5. (c) Minority interest Balance at beginning of year 182 150 – – Acquisition of subsidiaries 1 86 – – Buy-out of minority interests – (39) – – Foreign currency translation difference (12) 2 – – Share of surplus in subsidiaries 28 9 – – Dividends paid and provided to minority interests (16) (26) – – Closing balance 183 182 – –

Consolidated $M Parent $M

As at As at As at As at Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

6. Receivables and prepayments Trade receivables 1,640 1,689 67 224 Prepayments 135 90 109 53 60 Due from subsidiaries 25 – – 3,088 4,749 | Due from associates 25 38 19 – – Future hedging of receivables – – 241 277 Other receivables 458 15 28 15 Total receivables and prepayments 2,271 1,813 3,533 5,318

2005 ANNUAL REPORT At 31 May 2005, unrealised gains and losses associated with currency hedging contracts held other than for an on balance sheet debtor have been recognised in the Parent Company and then transferred to a subsidiary company. The effect of this is to recognise the future hedging of receivables of $241 million (31 May 2004: $277 million) and an equivalent increase in amounts payable to subsidiaries in the Parent Company (Note 12). There is no impact on the earnings of the Parent or Group. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

As at As at As at As at Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

7. Inventories Raw materials 484 402 – – Finished goods 2,761 2,459 – – Total inventories 3,245 2,861 – –

8. Property, plant and equipment At cost Land 140 149 2 1 Buildings 1,181 1,204 8 13 Plant, vehicles and equipment 3,651 3,475 79 57 Capital work in progress 460 290 3 1 Total cost 5,432 5,118 92 72

Accumulated depreciation Buildings 165 149 1 2 Plant, vehicles and equipment 970 773 50 35 Total accumulated depreciation 1,135 922 51 37

Net book value Land 140 149 2 1 Buildings 1,016 1,055 7 11 Plant, vehicles and equipment 2,681 2,702 29 22 Capital work in progress 460 290 3 1 Total property, plant and equipment 4,297 4,196 41 35

9. Investments Associates 10,24 319 274 58 48 Subsidiaries 24 – – 7,245 5,369 Other investments 12 169 6 8 Total investments 331 443 7,309 5,425 61 | Included within other investments are publicly traded investments with the following values: Carrying value – 155 – – Market value – 290 – –

The investment in associates held by the Parent entity represents part of the Group’s investment in the Dairy Partners 2005 ANNUAL REPORT Americas entities, which are included within the consolidated analysis provided in Note 10. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M

As at As at Notes 31 May 2005 31 May 2004

10. Investment in associates At cost 375 335 Impairment of investment (2) (2) Post-acquisition share of reserves (19) (32) Dividends received (35) (27) Total investment in associates 9 319 274

Goodwill included in investment in associates balance: Opening balance 107 115 Goodwill arising on acquisition 24 – Amortisation of goodwill (7) (8) Closing balance 124 107

Comprising: Goodwill arising on acquisition of associates 139 115 Accumulated amortisation (15) (8) 124 107 Total investment in associates comprises: Corporation Inlaca, CA 24 29 DPA Manufacturing Holdings Limited 45 35 Dairy Partners Americas Brasil Limitada 100 90 Dairy Partners Americas Argentina SA – 2 DPA del Ecuador S.A. 22 – AFF P/S 65 64 Britannia New Zealand Foods PVTE Limited 18 7 DairiConcepts Management, LLC 27 24 Dairy Industries (Jamaica) Limited 7 8 Other 11 15 Total investment in associates 319 274

Movement in investment in associates: Opening balance 274 355 62 Acquired during the year 45 – | Disposed of during the year (4) – Transferred to investment in subsidiaries (1) (26) Impairment of investment – (2) Share of total recognised revenues and expenses 22 (6) Foreign currency translation difference (9) (34) Dividends received (8) (10) 2005 ANNUAL REPORT Other – (3) Closing balance 319 274

Share of total recognised revenues and expenses of associates: Operating surplus before taxation 30 1 Goodwill amortisation (7) (8) Taxation (expense) / credit (1) 1 Share of total recognised revenues and expenses 1 22 (6) Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M

As at As at Notes 31 May 2005 31 May 2004

11. Intangibles Goodwill on amalgamation and acquisition of subsidiaries: Cost 254 256 Accumulated amortisation (34) (20) 220 236 Brands: Cost 1,368 1,401 Accumulated amortisation (10) (9) Impairment (116) (99) 1,242 1,293 Other: Cost 76 79 Accumulated amortisation (26) (19) Impairment (43) (43) 7 17 Total intangibles 1,469 1,546

Goodwill: Opening balance 236 175 Arising on acquisition of subsidiaries 4 – Arising on acquisition of minority interest (6) 73 Amortisation 2 (14) (12) Closing balance 220 236

Brands: Opening balance 1,293 1,305 Impairment during the year 2 (32) (90) Impairment reinstatement 2 15 90 Disposal of subsidiary 19 (b) (11) – Foreign currency translation difference (22) (9) 63

Amortisation 2 (1) (3) | Closing balance 1,242 1,293

Other: Opening balance 17 19 Research & development 3 8 2005 ANNUAL REPORT Transferred to property, plant and equipment (6) – Amortisation 2 (7) (10) Closing balance 7 17 Total intangibles 1,469 1,546 Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

As at As at As at As at Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

12. Payables and accruals Trade payables 373 386 – – Accruals 355 302 70 35 Employee entitlements 151 131 12 9 Due to subsidiaries 25 – – 975 1,792 Due to associates 25 – 1 – – Other 104 164 49 31 Total payables and accruals 983 984 1,106 1,867

13. Provisions Provision for restructuring and rationalisation: Opening balance 29 – 1 – Provisions arising from acquisition – 18 – – Raised during the year 2 28 – 8 Utilised during the year (15) (17) – (7) Reclassifications within note 13 (1) – (1) – Closing balance 15 29 – 1 Legal claims provisions: Opening balance 63 66 55 66 Provisions arising from acquisition – 6 – – Raised during the year 9 23 9 21 Released during the year – (22) – (22) Utilised during the year (7) (10) – (10) Reclassifications within note 13 9 – 9 – Reclassifications from parent to other group entities – – (14) – Closing balance 74 63 59 55 Other provisions: Opening balance 82 43 38 1 Transferred from other group entities – – 13 – Provisions arising from acquisition – 3 – – Raised during the year 35 52 12 37 Utilised during the year (56) (16) (44) – Reclassifications within note 13 (8) – (8) – 64 Reclassifications from other | balance sheet categories 8 – 6 – Closing balance 61 82 17 38 Total provisions 150 174 76 94 Provisions are included within the statement of financial position as follows: Current liabilities 88 128 23 58 2005 ANNUAL REPORT Non-current liabilities 62 46 53 36 Total provisions 150 174 76 94

The nature of the above provisions is as follows:

• The provision for restructuring and rationalisation includes obligations relating to restructuring and other rationalisation costs. • The legal claims provision includes global estimates for legal matters. The timing and amount of the future obligations are uncertain, as they are contingent on the outcome of a number of judicial proceedings. • Other provisions arise globally in a number of subsidiaries in the normal course of business. More specific information has not been given on some provisions as the Directors believe this disclosure would prejudice the position of the Company and the Group. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

As at As at As at As at 31 May 2005 31 May 2004 31 May 2005 31 May 2004

14. Current borrowings Commercial paper 939 436 939 436 Unsecured bank loans 234 315 168 200 Finance lease liabilities 23 24 – – Medium term notes 284 286 267 277 Total current borrowings 1,480 1,061 1,374 913

Finance lease liabilities are secured over the related item of property, plant and equipment. The associated minimum lease payments included in current finance lease liabilities is $35 million (31 May 2004: $35 million).

Consolidated $M Parent $M

As at As at As at As at 31 May 2005 31 May 2004 31 May 2005 31 May 2004

15. Term borrowings Secured bank loans 2 4 – – Unsecured bank loans 20 43 – – Finance lease liabilities 159 185 – – Medium term notes 2,147 2,375 2,090 2,308 Perpetual notes 90 97 – – Total non-current borrowings 2,418 2,704 2,090 2,308

Non-current borrowings are repayable on the following terms: One to two years 1,076 461 949 281 Two to five years 740 1,778 550 1,583 Greater than five years 602 465 591 444 Total non-current borrowings 2,418 2,704 2,090 2,308

Secured bank loans are secured by a floating charge over the assets of the borrowing subsidiary. Finance lease liabilities are secured over the related item of property, plant and equipment.

Consolidated $M Parent $M

As at As at As at As at 31 May 2005 31 May 2004 31 May 2005 31 May 2004

Non-current finance lease liabilities include the 65 | following amounts: Minimum lease payments 185 195 – – Future interest cost (26) (10) – – Total non-current finance lease liabilities 159 185 – –

Non-current finance lease liabilities are repayable on the following terms: 2005 ANNUAL REPORT One to two years 23 24 – – Two to five years 129 147 – – Greater than five years 7 14 – – Total non-current finance lease liabilities 159 185 – –

The perpetual notes issued by Bonlac Foods Limited are unsecured subordinated interest bearing obligations. Interest is payable on a semi-annual basis at a rate of 8.96% per annum (31 May 2004: 9.09%). The notes are listed on the Australian Stock Exchange. The perpetual notes have no fixed maturity date and continue in existence until redeemed by Bonlac Foods Limited. They may be redeemed in part or full by Bonlac Foods Limited at any time. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

As at As at As at As at Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

16. Deferred taxation Opening balance 53 106 (90) (142) Acquired on acquisition of subsidiary 19 (a) – 1 – – Deferred taxation included in taxation expense 3 (46) (54) 9 52 Closing balance 7 53 (81) (90)

The deferred taxation liability is represented by: Property, plant and equipment 225 201 1 – Employee entitlements (45) (45) (6) (4) Inventories (22) (21) – – Financial arrangements 35 83 1 1 Receivables, payables and provisions (51) (40) (6) (17) Other (37) (25) 2 – Deferred tax liability / (asset) 105 153 (8) (20) Tax losses recognised New Zealand (73) (70) (73) (70) Tax losses recognised offshore (25) (30) – – Total deferred taxation liability / (asset) 7 53 (81) (90)

17. Capital notes The capital notes are unsecured subordinated interest bearing obligations. Interest is payable on a quarterly basis at a rate of 7.73% per annum (31 May 2004: 6.55%). This rate is reset on 10 July each year. The capital notes have no fixed maturity date and continue in existence until redeemed by the Company on an election date, or otherwise purchased by the Company through the secondary market, or off market after allotment with agreement from the holder, or are redeemed or purchased by the Company from its shareholders in accordance with the Company’s constitution. The capital notes have an election date of 10 July in each year. The Company has the option to redeem all or part of the capital notes for cash on each election date.

66 | 2005 ANNUAL REPORT Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

Year ended Year ended Year ended Year ended Notes 31 May 2005 31 May 2004 31 May 2005 31 May 2004

18. Cash flows 18. (a) Reconciliation of net surplus / (deficit) to net cash flows from operating activities Net surplus / (deficit) 219 16 155 (51) Non-cash items: Amortisation of intangibles 2 22 25 – – Depreciation 2 448 441 20 27 Brand impairment 2 32 90 – – Brand impairment reinstatement 2 (15) (90) – – Movement in deferred taxation 3,16 (46) (54) 9 52 Gain on disposal of investments 1 (243) – – – (Gain) / loss on disposal of property plant and equipment 1,2 (14) 9 (7) 1 Impairment of investment in associate 10 – 2 – – Share of net (surplus) / deficits of associates after taxation 1,10 (22) 6 – – Impact of Bonlac Foods Limited acquisition 19 (a) (1) (21) – – Other non cash items 12 (23) (1) (5) Revaluation of investments in subsidiaries to net asset backing 2 – – (528) (301) 173 385 (507) (226)

Movement in working capital decrease / (increase): Movement in receivables and prepayments 6 4 142 137 59 Movement in inventories 7 (384) (51) – – Movement in current taxation balances (21) 13 4 (199) Movement in other current assets and other receivables (395) (4) (11) (2) Movement in owing to suppliers 275 332 279 333 Movement in payables, accruals and other liabilities (36) (43) 21 (29) 67 Movement in amounts due to and | from associates 6,12 (20) (38) – – Movement in provisions 13 (24) 23 (18) 96 (601) 374 412 258 Items classified as investing and financing activities 437 4 (408) (167) 2005 ANNUAL REPORT Net cash flows from operating activities 228 779 (348) (186)

18. (b) Non cash investing and financing transactions For the Group, there were no material non-cash transactions for the year ended 31 May 2005 (for 31 May 2004 non-cash transactions included the acquisition of subsidiaries for non cash consideration (Note 19(a)), and the acquisition of $50 million of property, plant and equipment under finance leases). In 31 May 2004 the parent entity had buildings, plant and equipment transferred to it from other group entities with a book value of $52 million for no cash consideration Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

19. Business combinations The material business combinations during the year ending 31 May 2005 consisted of two disposals as outlined below:

19. (a) Acquisitions There were no material acquisitions for the year ended 31 May 2005. For the year ended 31 May 2004, the only material business combination was the acquisition on 9 September 2003 of an additional 25% of Bonlac Foods Limited (“BFL”) and the remaining 75% equity in NZMP (Australia) Pty Limited (renamed Fonterra (Australia) Pty Ltd) (“FAPL”) that the Group did not previously control. The consideration was of a non-cash nature and comprised of the Group extinguishing debt (a transaction which took place on 25 June 2003), modifying its contractual rights in respect of various marketing and other arrangements to manage BFL, and to forego rights to a special dividend from BFL. From 9 September 2003 the operating results of BFL and FAPL consisting of an operating deficit after tax of $33 million to 31 May 2004 were included in the Group Statement of Financial Performance. Acquisitions had the following impact on the assets and liabilities of the Group:

Consolidated $M

On acquisition On acquisition Notes 31 May 2005 31 May 2004

Cash – 39 Receivables and prepayments – 121 Inventories – 62 Other current assets – 1 Total current assets – 223

Property, plant and equipment – 348 Other non-current assets – 15 Total non-current assets – 363 Total assets – 586

Payables and accruals – 88 Provisions 13 – 27 Current borrowings – 12 68 Deferred taxation liability 16 – 1 | Total current liabilities – 128

Term borrowings – 261 Other non-current liabilities – 1 Total non-current liabilities – 262

2005 ANNUAL REPORT Total liabilities – 390 Net assets – 196 Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M

On acquisition On acquisition Notes 31 May 2005 31 May 2004

19. (a) Acquisitions (continued) Net assets – 196

Minority interests – (86) Transfer investment in associates and other investments to investment in subsidiaries – (29) Extinguishment of debt – (45) Cash consideration – – Group share of uplift in fair value of assets 2 – (18) Discount arising on acquisition – 18

The discount on acquisition arising has been allocated to non-monetary assets as follows:

Inventories – 3 Property, plant and equipment – 15 – 18

The discount on acquisition recognised in income in the current period totals $1 million (31 May 2004: $3 million).

19. (b) Disposals There were two material disposals during the year ending 31 May 2005 being the disposal of the Group’s Fonterra Brands’ interests in Mexico and Bangladesh as follows: On 1 February 2005, the Group divested its ownership in New Zealand Milk Products (Bangladesh) Limited, with a net nil impact on the Group result. On 2 March 2005, the Group divested 100% of its Fonterra Brands Mexican group of companies which includes: Milk Products Holding (Mexico) Limited (MPHM) and its subsidiaries: Servilac SA de CV; New Zealand Milk (Mexico) Holdings SA de CV; New Zealand Milk (Mexico) SA de CV; Lácteos Finos Mexicanos SA de CV. and an associated brand holding company Xemlet Global Limited. The Mexican disposal gave rise to a gain on disposal of $33 million. In addition the transaction also triggered a brand 69 reinstatement of $9 million and the recognition of tax losses not previously recognised, totalling $8 million. Therefore the | total gains to the Group forming part of the current year result arising from this transaction amounted to $50 million. 2005 ANNUAL REPORT Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

19. (b) Disposals (continued) The disposals had the following impact on the assets and liabilities of the Group:

Consolidated $M

On disposal On disposal Notes 31 May 2005 31 May 2004

Cash balances – – Net current assets 15 – Property, plant and equipment 17 – Intangibles 11 11 – Other non-current assets 8 – Non-current liabilities (16) – Provisions (31) – Net assets 4 –

Net cash proceeds 37 –

Gain on disposal 33 –

Reconciliation to statements of cash flows: Cash proceeds received for net assets 37 – Settlement of intercompany loans by acquirer 27 –

Total cash received 64 –

20. Financial instruments The Group is subject to a number of financial risks, which arise as a result of its operational activities. To manage and limit the effect of those financial risks, the Board of Directors has approved a Treasury Policy that covers defined limits and delegated authority levels, and authorised use of various financial instruments. The policies and financial instruments being utilised at balance date are reported below. Commodity price risk Fluctuations in world dairy commodity prices can have a significant impact on the Group’s sales revenue and inventory sales. The Group is currently unable to hedge its exposure to commodity price risk due to the absence of any effective commodity price hedging markets. 70

| Foreign exchange risk Foreign exchange risk is the risk of cash flow uncertainty that may arise from a movement in foreign exchange rates to which the Group may be exposed. The main impacts of foreign exchange movements on the Group arise from:

• Transactional risk – variations in the New Zealand dollar value of the Group’s net foreign cash flows. • Translation risk – the value of the Group’s investment in foreign subsidiaries and associates and the Group’s foreign 2005 ANNUAL REPORT currency debt. Approximately three quarters of the Group’s net foreign exchange exposure is against the United States dollar. The Group’s objective in managing foreign exchange risk is to reduce the volatility of earnings from foreign exchange movements, and to provide greater certainty around the forecast payout. The Parent company operates a centralised Group Treasury that uses forward exchange contracts, currency options and cross currency interest rate swaps to manage these risks in accordance with the Board approved Treasury Policy and delegated authorities. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

20. Financial instruments (continued) Notional and principal balances The notional or principal contract amounts of foreign exchange instruments outstanding at balance date are:

Consolidated and Parent $M

As at As at 31 May 2005 31 May 2004

In relation to receivables and future sales: Sold forward foreign exchange contracts (2,085) (1,565) Purchased forward foreign exchange contracts 6,316 7,792 Net forward foreign exchange contracts 4,231 6,227

Sold currency option contracts (670) (258) Purchased currency option contracts 4,300 1,880 Net currency options 3,630 1,622

Net contracts in relation to receivables and future sales 7,861 7,849

In relation to borrowings: Sold forward foreign exchange contracts (853) (513) Purchased forward foreign exchange contracts 1,735 966 Net forward foreign exchange contracts 882 453 Cross currency interest rate swaps 1,735 2,019 Net contracts in relation to borrowings 2,617 2,472

The Parent company has a further $31 million (31 May 2004: $70 million) of net foreign exchange contracts outstanding with subsidiary companies as at 31 May 2005. Bonlac Foods Ltd has also entered into currency option contracts, being sold currency options of $60 million, and purchased currency options of $55 million (31 May 2004: Nil).

Interest rate risk Interest rate risk is the risk that the Group’s cost of funds changes as a result of changes in interest rates that the Group pays on its outstanding debt.

The Group’s objective in interest rate risk management is to minimise the cost of debt. In accordance with the Treasury Policy, the Group uses interest rate swaps (including cross-currency interest rate swaps) to manage its interest rate risk within Board approved limits. 71 | Notional and principal balances The notional or principal contract amounts of interest rate instruments outstanding at balance date are:

Consolidated and Parent $M

As at As at 2005 ANNUAL REPORT 31 May 2005 31 May 2004

Interest rate swaps 4,909 3,191 Cross currency interest rate swaps 1,735 2,019 6,644 5,210 Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

20. Financial instruments (continued) Repricing analysis The following tables identify the periods in which interest rates are subject to review on financial assets and liabilities.

31 May 2005 Consolidated $M

Effective Total 6 6-12 1-2 2-5 >5 Interest Carrying Months Months Years Years Years Rate Value or Less

Assets Cash balances 7%116116–––– Receivables and prepayments – 2,271 2,271–––– Total 2,387 2,387––––

Liabilities Payables and accruals / owing to suppliers – 1,965 1,965–––– Bank overdraft 7%7979–––– Borrowings (excluding perpetual notes) 7% 3,808 1,817 72 978 343 598 Perpetual notes 9%9090–––– Capital notes 8%483483–––– Total 6,425 4,434 72 978 343 598

Off balance sheet instruments Interest rate instruments – – (334) (202) 406 (461) 591 Repricing gap – (4,038) (2,381) (274) (572) (804) (7)

31 May 2004 Consolidated $M

Effective Total 6 6-12 1-2 2-5 >5 Interest Carrying Months Months Years Years Years Rate Value or Less

Assets Cash balances 5% 127 127–––– 72 Receivables and prepayments – 1,813 1,813–––– | Total 1,940 1,940––––

Liabilities Payables and accruals / owing to suppliers – 1,691 1,691–––– Bank overdraft 5% 33 33–––– 2005 ANNUAL REPORT Borrowings (excluding perpetual notes) 6% 3,668 1,450 – 314 1,478 426 Perpetual notes 9% 97 97–––– Capital notes 7% 370 370–––– Total 5,859 3,641 – 314 1,478 426

Off balance sheet instruments Interest rate instruments – (340) (425) (922) 1,283 404 Repricing gap (3,919) (2,041) (425) (1,236) (195) (22) Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

20. Financial instruments (continued)

31 May 2005 Parent $M

Effective Total 6 6-12 1-2 2-5 >5 Interest Carrying Months Months Years Years Years Rate Value or Less

Assets Cash balances 7%11–––– Receivables and prepayments – 3,533 3,533–––– Total 3,534 3,534––––

Liabilities Payables and accruals / owing to suppliers – 2,121 2,121–––– Bank overdraft 7%88–––– Borrowings 7% 3,464 1,650 60 949 214 591 Capital notes 8%483483–––– Total 6,076 4,262 60 949 214 591

Off balance sheet instruments Interest rate instruments – – (334) (202) 406 (461) 591 Repricing gap (2,542) (1,062) (262) (543) (675) –

31 May 2004 Parent $M

Effective Total 6 6-12 1-2 2-5 >5 Interest Carrying Months Months Years Years Years Rate Value or Less

Assets Cash balances 5% 26 26–––– Receivables and prepayments – 5,318 5,318–––– Total 5,344 5,344––––

Liabilities Payables and accruals / owing to 73 | suppliers – 2,603 2,603–––– Bank overdraft 5% 11 11 Borrowings 6% 3,221 1,400 – 134 1,283 404 Capital notes 7% 370 370–––– Total 6,205 4,384 – 134 1,283 404 2005 ANNUAL REPORT Off balance sheet instruments Interest rate instruments – – (340) (425) (922) 1,283 404 Repricing gap (861) 620 (425) (1,056) – – Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

20. Financial instruments (continued) Liquidity risk Liquidity risk is the risk that the Group is unable to meet its obligations as and when the amounts fall due. In accordance with the Treasury Policy, the Group has policies and limits in place to manage liquidity risk. The Group has an undrawn funding facility of $1.26 billion as at 31 May 2005 (31 May 2004: $1.26 billion). Credit risk Credit risk is the risk of loss arising from the failure of a debtor or trading counterparty to honour fully any financial or contractual obligation. The Group incurs credit risk as a result of transactions with customers from its normal sales activities and transactions with financial institutions. Contracts for sale are only entered into with customers whose credit limits are in accordance with the Group’s delegated authorities approved by the Board. The maximum credit risk on cash, receivables and other investments is best represented by their carrying value. The maximum credit risk on off-balance sheet financial instruments is equivalent to the values reported in the Fair Value Summary table. Group Treasury has policy covering exposures to financial institutions, and these are monitored against approved limits on a daily basis. The Group does not hold collateral or security in relation to credit risk, and has no undue concentrations of credit risk. Fair value The carrying value of financial instruments is equivalent to their fair value, unless where summarised below:

Consolidated $M As at 31 May 2005 As at 31 May 2004

Carrying Fair Carrying Fair value value value value

Liabilities Borrowings (3,808) (3,895) (3,668) (3,717) Perpetual notes (90) (100) (97) (96) Capital notes (483) (523) (370) (396)

Derivative instruments Forward foreign exchange contracts 54 274 227 489 Currency options 106 130 47 35 Cross currency interest rate swaps (267) (257) (188) (176) 74 Interest rate swaps 10 42 729 |

Parent $M As at 31 May 2005 As at 31 May 2004

Carrying Fair Carrying Fair value value value value 2005 ANNUAL REPORT Liabilities Borrowings (3,464) (3,551) (3,221) (3,300) Capital notes (483) (523) (370) (396)

Derivative instruments Forward foreign exchange contracts 274 274 490 490 Currency options 130 130 35 35 Cross currency interest rate swaps (267) (257) (188) (176) Interest rate swaps 10 42 729 Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Consolidated $M Parent $M

As at As at As at As at 31 May 2005 31 May 2004 31 May 2005 31 May 2004

21. Contingent liabilities Contingent liabilities comprise: Customs and excise bonds 17 8 – – Underwriting commitments, performance bonds and other 9 4 – – Aggregate amount of associates liabilities for which the group is jointly and severally liable 16 – – – Total contingent liabilities 42 12 – –

In the normal course of its business Fonterra, its subsidiaries and associates are exposed to claims, legal proceedings and arbitrations that may in some cases result in costs to the Group. The Directors believe that these have been adequately provided for by the Group and there are no additional legal proceedings or arbitrations that are pending at the date of these financial statements that require provision or disclosure.

Consolidated $M Parent $M

As at As at As at As at 31 May 2005 31 May 2004 31 May 2005 31 May 2004

22. Commitments Capital commitments Buildings 6 15 – – Plant, vehicles and equipment 171 274 7 2 Share of associates’ capital commitments – 12 – – Total capital commitments 177 301 7 2

Operating lease commitments Non-cancellable operating lease commitments per annum: Less than one year 42 41 4 4 One to two years 27 32 4 4 Two to five years 43 54 10 11 75

Greater than five years 16 34 5 8 | Share of associates’ operating lease commitments 32 32 – – Total operating lease commitments 160 193 23 27

The Group leases premises, plant and equipment. 2005 ANNUAL REPORT Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

23. Segmental analysis The Group operates predominantly in two industrial segments – Ingredients and Consumer Products (predominantly Fonterra Brands) and two geographical segments - New Zealand and other. Ingredients’ operations comprise the manufacture and global marketing of dairy commodity and value added ingredients products, including trading dairy products on other manufacturers’ behalf. Consumer products operations comprise the production, marketing and sale of value-added milk powders, liquid milks and yoghurts, packaged natural cheese, processed cheese, butter, spreads and cream to retailers and foodservice businesses in more than 30 countries.

In the absence of a market based price for milk and in order to present the results of the Group in its two principal segments, the analysis set out below is based on the cost of milk for the Ingredients segment as being Fonterra’s Commodity Milk Price. This is the estimated payout for milk that Fonterra would have been able to make to enable it to recover all its costs, including a fair return on capital, based on its actual volume of supply but assuming that non- commodity products had been manufactured as commodity products and taking account of Fonterra’s actual plant configuration and the location of milk.

Consolidated $M Industry Segments Ingredients Consumer Eliminations Consolidated

Year ended Year ended Year ended Year ended Year ended Year ended Year ended Year ended 31 May 31 May 31 May 31 May 31 May 31 May 31 May 31 May All values are in $ millions 2005 2004 2005 2004 2005 2004 2005 2004

Sales to customers outside the group 8,548 8,194 3,775 3,636 – – 12,323 11,830 Inter-segment sales1 1,377 1,346 59 132 (1,436) (1,478) – – Total revenue 9,925 9,540 3,834 3,768 (1,436) (1,478) 12,323 11,830

Segment operating surplus excluding non-recurring items2,3,4 601 563 265 280 (43) (4) 823 839 Non-recurring income / (expense)5 13 83 193 (65) – – 206 18 Segment operating surplus 614 646 458 215 (43) (4) 1,029 857

Unallocated net interest expense (260) (239) Unallocated tax expense (25) (26) 76

| Value add payout component (525) (576) Group Net Surplus before minority interest 219 16 Segment assets6 8,372 7,970 3,849 3,648 (409) (506) 11,812 11,112

2005 ANNUAL REPORT 1 Inter-segment sales are on an arm’s length basis. 2 Represents earnings before interest and taxation calculated on the basis of cost of milk to the Ingredients business being the Fonterra Commodity Milk Price and adjusted for non-recurring items. 3 The revaluation of investments to net asset backing made in the parent entity, and the elimination of this adjustment were previously included in the Ingredients’ operating surplus and eliminations respectively, these have now been excluded. The prior year has been restated to be on a consistent basis. 4 Consumers’ prior year operating surplus has been restated to include an allocation of corporate costs to be on a consistent basis with the current year. 5 The non-recurring income / (expense) items represent the gain on sale of investments, brand (impairment) / reinstatements (note 2), and other. The prior year represents brand (impairment) / reinstatements and the Group share of uplift in Bonlac Foods fair values (notes 2, 19). 6 A right of set off has been established for intercompany advances and funding. The prior year has been restated to be on a consistent basis. Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

23. Segmental analysis (continued)

Consolidated $M Geographical Segments New Zealand Other Eliminations Consolidated

Year ended Year ended Year ended Year ended Year ended Year ended Year ended Year ended 31 May 31 May 31 May 31 May 31 May 31 May 31 May 31 May All values are in $ millions 2005 2004 2005 2004 2005 2004 2005 2004

Sales to customers outside the group 9,656 9,105 2,667 2,725 – – 12,323 11,830 Inter-segment sales1 1,180 1,478 32 – (1,212) (1,478) – – Total revenue 10,836 10,583 2,699 2,725 (1,212) (1,478) 12,323 11,830

Segment operating surplus excluding non-recurring items2 720 709 100 133 3 (3) 823 839 Non-recurring income / (expense)3 198 76 8 (58) – – 206 18 Segment operating surplus 918 785 108 75 3 (3) 1,029 857

Unallocated net interest expense (260) (239) Unallocated tax expense (25) (26) Value add payout component (525) (576) Group Net Surplus before minority interest 219 16 Segment assets 10,365 10,010 1,732 1,308 (285) (206) 11,812 11,112

1 Inter-segment sales are on an arms length basis. 2 Represents earnings before interest and taxation calculated on the basis of cost of milk to the Ingredients business being the Fonterra Commodity Milk Price and adjusted for non-recurring items. 3 The non-recurring income / (expense) items represent brand (impairment) / reinstatements, the gain on disposal of investments and other. The prior year represents brand (impairment) / reinstatements and Group share of uplift in Bonlac Foods fair values in New Zealand (notes 2, 19). The following is supplementary information providing details of the operating revenues by country of domicile of the customer.

Consolidated $M

Year ended Year ended 31 May 2005 31 May 2004

77 Ingredients | Americas 2,332 2,047 Asia 2,565 2,369 Australia & New Zealand 1,877 1,784 Europe, Africa & the Middle East 1,774 1,994 Total Ingredients’ Revenues 8,548 8,194 2005 ANNUAL REPORT

Consumer Americas 673 678 Asia 963 892 Australia & New Zealand 1,769 1,806 Europe, Africa & the Middle East 370 260 Total Consumer Revenues 3,775 3,636

Total Group Revenues 12,323 11,830 Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

24. Group entities All subsidiaries (consolidated), associates and joint ventures (equity accounted) are involved in either marketing, distribution, processing, technology or financing dairy products. All Group entities have a balance date of 31 May unless otherwise indicated. The significant subsidiaries, associates and joint ventures of the Group are listed below.

Ownership Ownership interests (%) interests (%) Overseas subsidaries Country of incorporation As at 31 May 2005 As at 31 May 2004

New Zealand Milk (Australiasia) Pty Limited Australia 100 93 NZMP (UK) Ltd3 United Kingdom 100 100 Fonterra (Europe) GmbH Germany 100 100 Fonterra (Logistics) Ltd United Kingdom 100 100 Sociedad Productores de Leche S.A., Soprole1 Chile 57 55 Fonterra (Mexico) S.A. de C.V.1 Mexico 100 100 New Zealand Milk (Mexico) S.A. de C.V. Mexico – 100 Lacteos Finos Mexicanos S.A. de C.V. Mexico – 100 Fonterra (USA) Inc USA 100 100 New Zealand Milk Lanka (Private) Ltd Sri Lanka 100 100 Fonterra (Middle East) EC Bahrain 100 100 PT New Zealand Milk Indonesia Indonesia 100 100 New Zealand Milk (Malaysia) Sdn Bhd Malaysia 100 100 New Zealand Milk Philippines, Incorporated Philippines 100 100 New Zealand Milk (Hong Kong) Ltd Hong Kong 100 100 New Zealand Milk (Singapore) Ltd Singapore 100 100 New Young Dairy Products Co. Ltd Taiwan 51 51 New Tai Milk Products Co. Ltd Taiwan 51 51 Fonterra (China) Ltd Hong Kong 100 100 Fonterra (SEA) Pte Ltd Singapore 100 100 Fonterra (SA) (Proprietary) Limited South Africa 100 100 Peters & Brownes Foods Ltd Australia 100 93 New Zealand Milk Products (Thailand) Co. Ltd Thailand 100 100 Bonland Dairies Pty Ltd Australia 100 93 Fonterra (Australia) Pty Ltd Australia 100 100 78 Australasian Food Holdings Pty Limited2 Australia 100 93 |

1 Balance Date 31 December (comparative ownership interest % consistent at 31 December 2004). 2 This company was migrated from New Zealand to Australia on 2 March 2004. 3 During 2004 and 2005 all NZMP companies are being renamed to Fonterra. 2005 ANNUAL REPORT Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

24. Group entities (continued)

Ownership Ownership interests (%) interests (%) New Zealand subsidiaries Country of incorporation As at 31 May 2005 As at 31 May 2004

Canpac International Limited New Zealand 100 100 Fencepost.com Limited New Zealand 100 100 Fonterra Insurance Limited New Zealand 100 100 Fonterra Research Centre Limited New Zealand 100 100 Mainland Products Limited New Zealand 100 93 New Zealand Dairy Board New Zealand 100 100 New Zealand Milk Limited New Zealand 100 100 Fonterra (New Zealand) Limited New Zealand 100 100 Fonterra Limited1 New Zealand 100 100 RD1 Limited New Zealand 100 100 The Lactose Company of NZ Limited New Zealand 100 100 Tip Top Ice Cream Company Limited New Zealand 100 93 ViaLactia Biosciences (NZ) Limited New Zealand 100 100

The ownership interest of the entities in the following table is less than or equal to 50%. However, they have been consolidated on the basis that the Group controls them based on its capacity to determine the financing and operating policies that guide the activities of these entities and has an entitlement to a significant level of ownership benefits.

Ownership Ownership interests (%) interests (%) Overseas subsidaries 50% or less ownership Country of incorporation As at 31 May 2005 As at 31 May 2004

New Zealand Milk (Mauritius) Ltd Mauritius 49 49 New Zealand Milk (U.A.E.) L.L.C. UAE 49 49 Saudi New Zealand Milk Products Company Ltd Saudi Arabia 49 49 Fonterra (Japan) Ltd Japan 50 50 Bonlac Foods Limited and subsidiary companies2 Australia 50 50 79 |

1 NZMP Limited was renamed to Fonterra Ltd on 8 June 2004. 2 The balance date of Bonlac Foods Limited is 30 June (comparative ownership interest % consistent at 30 June 2004). 2005 ANNUAL REPORT Notes to the Financial Statements For the year ended 31 May 2005 Fonterra Co-operative Group Limited

24. Group entities (continued) The ownership interest of the following entities is 50% or less and the Group is not considered to exercise a controlling interest. These entities are therefore accounted for as associates.

Ownership Ownership interests (%) interests (%) Overseas associates not consolidated Country of incorporation As at 31 May 2005 As at 31 May 2004

DairiConcepts Management L.L.C.1 USA 50 50 Corporacion Inlaca, C.A.1 Venezuela 25 25 DPA Manufacturing Holdings Limited1 Bermuda 50 50 Dairy Partners Americas Brasil Limitada1 Brazil 50 50 Dairy Partners Americas Argentina S.A.1 Argentina 50 50 DPA del Ecuador S.A.1,2 Ecuador 50 – Dairy Industries (Jamaica) Limited1 Jamaica 50 50 AFF P/S3 Denmark 25 25 Britannia New Zealand Foods PVTE Limited4 India 49 49

1 Balance date 31 December (comparative ownership interest % consistent at 31 December 2004). 2 A 50% interest in this entity was acquired on 1 July 2004. 3 Balance date 30 September (comparative ownership interest % consistent at 30 September 2004). 4 Balance date 31 March (comparative ownership interest % consistent at 31 March 2005).

25. Related party transactions Note 24 identifies all significant Group entities, including subsidiaries, associates and joint ventures. All of these entities, together with the non-significant subsidiaries, associates and joint ventures, are related parties of the Company. There are no additional related parties with whom material transactions have taken place. The Company has entered into the following material related party transactions: • Loans and advances to/from related parties (refer to notes 6 and 12); • Interest income and expense on loans and advances (the majority of Parent interest income disclosed in note 1 is from related parties); • Sale of inventories (the majority of Parent sales disclosed in note 1 is to related parties); • Group tax loss offsets (refer to note 3); and • The Parent acts as a central treasury function for the Group. The Company bears the cost of the following on behalf of certain subsidiaries: 80 • | Audit fees; • Rental expense; • Employee remuneration; and • Guarantees of borrowings / debt instruments. Directors and executives conduct business with the Parent and its subsidiaries in the normal course of their business activities as supplying shareholders. All of these transactions are conducted on commercial terms and conditions. Approximately 1% of

2005 ANNUAL REPORT payments to suppliers are paid to Directors and executives.

26. Subsequent events On 7 June 2005, Fonterra announced that it has entered into an agreement with Nestlé to acquire its plant at Dennington on Victoria’s South West coast, from 1 August 2005. Fonterra also disclosed that it is seeking to acquire from Bonlac Supply Company the fifty percent of Bonlac Foods Limited that it does not currently own. Fonterra, through Bonlac Foods Limited, is offering Bonlac Supply Company, capital notes in exchange for its shares in Bonlac Foods Limited. This transaction is subject to ratification by the Bonlac Supply Company shareholders. On 21 June 2005, a fire occurred at the Takaka site, in the upper South Island of New Zealand. Preliminary inspections of the site indicate the plant has sustained severe damage. The plant is insured under Fonterra Co-operative Group’s Global Insurance Programme and accordingly no material loss is expected to be incurred by the Group. Auditors’ Report To the shareholders of Fonterra Co-operative Group Limited

We have audited the financial statements on pages 46 to 80. The financial statements provide information about the past financial performance and cash flows of the Company and Group for the year ended 31 May 2005 and their financial position as at that date. This information is stated in accordance with the accounting policies set out on pages 50 to 55.

Directors’ Responsibilities The Company’s Directors are responsible for the preparation and presentation of the financial statements which give a true and fair view of the financial position of the Company and Group as at 31 May 2005 and their financial performance and cash flows for the year ended on that date.

Auditors’ Responsibilities We are responsible for expressing an independent opinion on the financial statements presented by the Directors and reporting our opinion to you.

Basis of Opinion An audit includes examining, on a test basis, evidence relevant to the amounts and disclosures in the financial statements. It also includes assessing: (a) the significant estimates and judgements made by the Directors in the preparation of the financial statements; and (b) whether the accounting policies are appropriate to the circumstances of the Company and Group, consistently applied and adequately disclosed. We conducted our audit in accordance with generally accepted auditing standards in New Zealand. We planned and performed our audit so as to obtain all the information and explanations which we considered necessary to provide us with sufficient evidence to give reasonable assurance that the financial statements are free from material misstatements, whether caused by fraud or error. In forming our opinion we also evaluated the overall adequacy of the presentation of information in the financial statements. We carry out other assignments on behalf of the Company and Group in the areas of taxation compliance, financial due diligence, financial assurance, and international accounting standard advisory services. Partners and employees of our firm may deal with the Company and Group on normal terms within the ordinary course of trading activities of the Company and Group. The firm has no other relationship with, or interest in, the Company and Group.

Unqualified Opinion We have obtained all the information and explanations we have required. In our opinion: (a) proper accounting records have been kept by the Company as far as appears from our examination of those records; and (b) the financial statements on page 46 to 80: 81

(i) comply with generally accepted accounting practice in New Zealand; and | (ii) give a true and fair view of the financial position of the Company and Group as at 31 May 2005 and their financial performance and cash flows for the year ended on that date. Our audit was completed on 19 July 2005 and our unqualified opinion is expressed as at that date. 2005 ANNUAL REPORT

Chartered Accountants Auckland Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Equity securities held at balance date In accordance with the New Zealand Exchange Limited Listing Rule 10.5.3(c), the following table identifies the Equity Securities in which each Director and their Associated Persons have a relevant interest as at 31 May 2005. The figure alongside each Director includes beneficially held securities, holdings by associated persons and joint holdings with associated persons. Changes pending to security entitlements at year end in respect of end of season adjustments do not constitute relevant interests.

Equity Securities held as at 31 May 2005 Shares SRRs

Malcolm Bailey 107,885 6,820 Harry Bayliss 219,691 Nil Greg Gent 309,583 24,357 Stuart Nattrass 4,109,999 21,584 Earl Rattray 201,944 18,651 Mark Townshend 1,491,954 61,083 Henry van der Heyden 405,575 Nil Jim van der Poel 3,287,376 48,382 John Wilson 1,213,798 34,189

Co-operative status In accordance with Section 10 of the Co-operative Companies Act 1996, the Directors of Fonterra Co-operative Group Limited unanimously resolved on 19 July 2005 that the company was, for the year ended 31 May 2005, a co-operative dairy company. The opinion was based upon the fact that:

• Throughout that period the principal activities of the Company have been the activities specified in section 35 of the Co-operative Companies Act 1996 which, as stated in clause 1.2 of the Company’s constitution, are the manufacture and sale of butter, cheese, dried milk, or casein, or any other product derived from milk or milk solids supplied to the Company by its shareholders; the sale to any person of milk or milk solids supplied to the Company by its shareholders; the collection, treatment, and distribution for human consumption of milk or cream supplied to the Company by its shareholders; • Throughout that period not less than 60 per cent of the voting rights attaching to shares in the Company have been held by supplying shareholders as defined in section 34 of the Co-operative Companies Act 1996.

Remuneration of directors

The fees paid to each Director of Fonterra Co-operative Group Limited are scheduled below. Fees

M G Bailey 99,283 H G Bayliss* 144,283 G R W France 106,088 82

| G W Gent 99,283 G S Hawkins 109,283 D M Hoare 99,283 J A Hood 8,154 I R Johnson 66,667

2005 ANNUAL REPORT S J Nattrass 99,283 E S Rattray 99,283 M G Townshend 99,283 H W van der Heyden 202,174 J W van der Poel 99,283 J S Wilson 99,283

Directors received no other remuneration or benefits from Fonterra except as disclosed below. Fees paid to Directors of subsidiary companies (including Fonterra Directors where they served as Directors of subsidiary companies) are indicated in the schedule of subsidiary company Directors.

*Includes remuneration paid to Mr Bayliss as Fonterra’s representative on the Board of Bonlac Foods Limited (Australia). Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Subsidiary company directors The following companies were subsidiaries of Fonterra Co-operative Group Limited as at 31 May 2005. Directors as at that date are listed; those who resigned during the year are denoted with an “R”. Alternate Directors are denoted with an “A”. Where an amount is given this represents the total Director’s remuneration and the value of other Director’s benefits received from the specific company during the year ended 31 May 2005.

616059 Limited: Fonterra Enterprises International Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

Anchor Ethanol Limited: Fonterra Enterprises Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

Anchor Superannuation Investments Limited: Fonterra Equities Limited: C L Gandell, K J Hampton, M D Mears (R), D Patterson, G M Cowan, J C Dale, G R Stuart (R) E S Rattray, D W C Scott, J Stronach, A R Whatmough, Fonterra Finance (N.Z.) Limited: A G Wilding G M Cowan, J C Dale, G R Stuart (R) Buttermark (NZ) Limited: Fonterra Finance Corporation Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R) Canpac International Limited: Fonterra Finance Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R) Dairy Industry Superannuation Scheme Fonterra Holdings (Americas) Limited: Trustee Limited: G M Cowan, J C Dale, G R Stuart (R) M A Apiata-Wade, P J Robertson, G Roper, D W C Scott, A D Steele, N W Walker, A G Wilding Fonterra Holdings (Argentina) Limited: G M Cowan, J C Dale, G R Stuart (R) Fencepost Live.ex Limited: D A C Coleman, J C Dale, G R Stuart Fonterra Holdings (Barbados) Limited: G M Cowan, J C Dale, G R Stuart (R) Fencepost.com Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra Holdings (Brazil) Limited: G M Cowan, J C Dale, G R Stuart (R) Ferndale Dairies Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra Holdings (Ecuador) Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra (APV) Limited: G M Cowan, D A Matthews, G R Stuart (R) Fonterra Holdings (Venezuela) Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra (Asia) Limited: G M Cowan, J C Dale Fonterra Holdings Limited: 83

G M Cowan, J C Dale, G R Stuart (R) | Fonterra (International) Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra Insurance Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra (Iran) Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra IP Limited: G M Cowan, D A Matthews, G R Stuart (R) Fonterra (Middle East) Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra Limited: 2005 ANNUAL REPORT G M Cowan, J C Dale, G R Stuart (R) Fonterra (New Zealand) Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra Manufacturing (Americas) Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra (Number One) Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra PGGRC Limited: G M Cowan, J C Dale, G R Stuart (R) Fonterra Corporate Research and Development Limited: Fonterra Projects Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R) Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Subsidiary Company Directors (continued)

Fonterra Receivables Limited: New Zealand Dairy Board: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

Fonterra Research Centre Limited: New Zealand Dairy Corporation Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

Fonterra Tech Limited: New Zealand Dairy Exporter Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

Fonterra TM Limited: New Zealand Dairy Group Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

Food Solutions Group 2000 Limited: New Zealand Milk (Australasian Holdings) Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

General Foods Corporation (N.Z.) Limited: New Zealand Milk (China) Limited: G L Beatty (R), G M Cowan, D A Matthews, G M Cowan, J C Dale, G R Stuart (R) R G O'Connor (R), G R Stuart (R) New Zealand Milk (CIS Holdings) Limited: Glencoal Energy Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R) New Zealand Milk (Denmark) Limited: Huttons Kiwi Limited: G M Cowan, J C Dale, G R Stuart (R) G L Beatty (R), G M Cowan, D A Matthews, New Zealand Milk (International) Limited: D A Pilkington (R), G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R) Key Ingredients New Zealand Limited: New Zealand Milk (Mauritius Investments) Limited: G M Cowan, J C Dale, G R Stuart (R) D A Matthews Knoll Holdings NZ Limited: New Zealand Milk Brands Limited: G L Beatty (R), G M Cowan, D A Matthews, G M Cowan, J C Dale, G R Stuart (R) R G O'Connor (R), G R Stuart (R) New Zealand Milk Limited: Mainland Products Limited: G M Cowan, J C Dale, G R Stuart (R) G L Beatty (R), G M Cowan, D A Matthews, D A Pilkington (R), G R Stuart (R) New Zealand Milk Products Limited: G M Cowan, J C Dale, G R Stuart (R) Meadow Fresh Limited: G L Beatty (R), G M Cowan, D A Matthews, Nzagbiz Limited: D A Pilkington (R), G R Stuart (R) G M Cowan, D A Matthews

84 Milk Products Finance Limited: NZM (Dairy Holdings) Limited: | G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

Milk Products International Limited: NZMP Limited: G M Cowan, J C Dale, G R Stuart (R) G M Cowan, J C Dale, G R Stuart (R)

Naturalac Nutrition Limited: PasturePak Limited: G L Beatty (R), G M Cowan, D A Matthews, G M Cowan, J C Dale, G R Stuart (R)

2005 ANNUAL REPORT D A Pilkington (R), G R Stuart (R) Peters Ice Cream Company (N.Z.) Limited: NDS Fuel Limited: G L Beatty (R), G M Cowan, D A Matthews, G M Cowan, J C Dale, G R Stuart (R) R G O'Connor (R), G R Stuart (R)

New Zealand Cheese Limited: PIC New Zealand Limited: G M Cowan, J C Dale, G R Stuart (R) G L Beatty (R), G M Cowan, D A Matthews, D A Pilkington (R), G R Stuart (R) New Zealand Cheese Promotions Limited: G M Cowan, J C Dale, G R Stuart (R) Pinnacle Holdings NZ Limited: G L Beatty, R G O'Connor Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Subsidiary Company Directors (continued)

Promak No. 2 Limited: A.C.N. 113 345 430 Pty Ltd [Australia]: G M Cowan, J C Dale, G R Stuart (R) B S Donnison, P L Thorn

Promak Technology (NZ) Limited: Anchia Milk Products (Guangzhou) Ltd [China]: G M Cowan, J C Dale, G R Stuart (R) Ng L S, L Pakiam (R), A R Sarker, M D Wynne, A Zhi Yu

RD1 Limited: Anchor Foods (Malaysia) Sdn Bhd [Malaysia]: G M Cowan, J C Dale, G R Stuart (R) Chan T Y, Lee W N

RD1.COM Limited: Anchor Foods Limited [UK]: G M Cowan, J C Dale, G R Stuart (R) D A Pilkington

SAITL Technologies Limited: Anmum (Malaysia) Sdn. Bhd. [Malaysia]: R R Soar, P J Spooner, P J van Boheemen, J S Wilson G P Gomez Lackington, Lee W N, Ng L S (R), L Pakiam (R), A R Sarker South Auckland Independent Testing Society Limited: R Andela (A) , A Gane (A) , P A Larking, M E Matthews (A), Arctic Foods Pty Ltd [Australia]: R R Soar, P J Spooner (A) , P J van Boheemen, J S Wilson G L Beatty, D A Pilkington, N A Thomas

Sovenz Limited: Australasian Food Holdings Pty Limited [Australia]: G M Cowan, J C Dale, G R Stuart (R) G L Beatty, G M Cowan, D K Mallinson, D A Matthews, G R Stuart (R) The Lactose Company of New Zealand Limited: G M Cowan, J C Dale, G R Stuart (R) Australian Dairy Ingredients Pty Limited [Australia]: G L Beatty, A M Coleman (R), G M Cowan, D K Mallinson, Tip Top Ice Cream Company Limited: D A Matthews, G R Stuart (R), G R Stuart (A) (R) G L Beatty (R), G M Cowan, D A Matthews, R G O'Connor (R), D A Pilkington (R), G R Stuart (R) Bonlac Finance Ltd [Australia]: B S Donnison, S G Nelson, P L Thorn Tip Top Investments Limited: G L Beatty (R), G M Cowan, D A Matthews, Bonlac Foods Ltd [Australia]: R G O'Connor (R), G R Stuart (R) H G Bayliss (R), R J Campbell (AUD 54,354), N R Campbell (AUD 143,427), J C Dale, K D Jackson (AUD 65,001), Top Hat Convenience Foods Limited: P L Myers (R) (AUD 13,477), M F Parkin, J Waldvogel, G L Beatty (R), G M Cowan, D A Matthews, G R Stuart (A) D A Pilkington (R), G R Stuart (R) Bonland Cheese Trading Pty Ltd [Australia]: Town & Country Agri Centres Limited: G L Beatty, A M Coleman (R), G M Cowan, D K Mallinson, G M Cowan, J C Dale, G R Stuart (R) D A Matthews, G R Stuart (R) ViaLactia Biosciences (NZ) Limited: Bonland Dairies Pty Ltd [Australia]: G M Cowan, G R Stuart (R) 85 G L Beatty, A M Coleman (R), G M Cowan, D K Mallinson, | ViaLactia Bovine Limited: D A Matthews, G R Stuart (R) G M Cowan, G R Stuart (R) Broomco (1984) Limited [UK]: ViaLactia Clover Limited: G R Sharma G M Cowan, G R Stuart (R) Comercial Dos Alamos S.A. [Chile]: Whareroa Co-Generation Limited: A Alarcón Araya, H Covarrubias Lalanne, F Gana Eguiguren, 2005 ANNUAL REPORT G M Cowan, J C Dale, G R Stuart (R) J F Silva Barroilhet, J M Ugarte Undurraga

Whareroa Farm Limited: Comercial Santa Elena S.A. [Chile]: G M Cowan, J C Dale, G R Stuart (R) A Alarcón Araya, H Covarrubias Lalanne, F Gana Eguiguren, J F Silva Barroilhet, J M Ugarte Undurraga Whareroa Power Limited: G M Cowan, J C Dale, G R Stuart (R) Cottee Nutriceuticals Pty. Ltd [Australia]: D K Mallinson, G R Stuart A.C.N. 111 834 489 Pty Ltd [Australia]: G L Beatty, D K Mallinson Cottee Nutritionals Pty Ltd [Australia]: D K Mallinson, G R Stuart Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Subsidiary Company Directors (continued)

Dairy Enterprises (Chile) S.A. [Chile]: Fonterra (Korea) Ltd [South Korea]: M P Campbell, R D Castro Urdiales (R), G M Cowan, J C Dale, B J Choi (R), J C Dale, M B N Dewdney, R M Kennerley (R), J C Dale (A) (R), S Diez (A) , A J Duncan, J P Egaña (A), M J Newell, G R Stuart, B P D Taylor (R) C Herrera (A) , L O Herrera (A) , L A J Kavanagh (A) (R), Fonterra (Latam) Ltd [Bermuda]: J L Letelier Azzari (R), S Obach (A) (R), S Obach (A) , F Scott, G M Cowan, J C Dale, C G Garrod (R), A L Smith (A) (R), G R Stuart (R), G Varela Alfonso (A) (R) G R Stuart (R), N G Trollope (R) Dairy Enterprises International (Chile) Limited [Cayman Fonterra (Logistics) Ltd [UK]: Islands]: G L Waterhouse S R Armstrong, R D Castro Urdiales, S A Eglinton Fonterra (Mexico) S.A. de C.V. [Mexico]: Dairy Fresh Pty. Ltd. [Australia]: L Barona Mariscal (A) , M D Foster (R), J R López Cortés (A), G L Beatty, A M Coleman (R), G M Cowan, D K Mallinson, D A Matthews, J A Monroy Adame (A) , R O'Neill, B T Willis, D A Matthews, G R Stuart (R) C J Wilson (R) Dairymas (Malaysia) Sdn Bhd [Malaysia]: Fonterra (Middle East) E.C. [Bahrain]: W I A B W Ismail, Ng L S (R), W I B W Nik, L Pakiam (R), M P J Bates, J C Dale, M G Patel, S A R Roberts (R), G R Stuart A R Sarker, M D Wynne Fonterra (Netherlands) B.V. [Netherlands]: Fonterra (AEM Management Services) SARL [France]: G R Stuart S A O'Keefe (R), G L Waterhouse Fonterra (Perú) S.A. [Peru]: Fonterra (Australia) Pty Ltd [Australia]: R Chaw, M D Foster, B T Willis M Beniston (R), J C Dale, B M Ryan, G R Stuart Fonterra (SA) (Proprietary) Limited [South Africa]: Fonterra (Brasil) Ltda [Brazil]: K I McInteer, S A O'Keefe (R), M Tweed, G L Waterhouse D H Broad, M D Foster (R), B T Willis Fonterra (SEA) Pte. Ltd. [Singapore]: Fonterra (Central America) S.A. [Panama]: M B N Dewdney (R), R M Kennerley (R), A J Kirby-Lewis (R), M D Foster, A M Garcia Pacheco (R), M d R Garcia de Pullin, M J Newell, C J Wilson B T Willis Fonterra (Thailand) Limited [Thailand]: Fonterra (Centro America) S.A. [Guatemala]: M B N Dewdney (R), R M Kennerley (R), M J Newell, M D Foster, M d R Garcia de Pullin, A M Garcia Pacheco (R), K Vunthanadit, C J Wilson B T Willis Fonterra (USA) Inc [USA]: Fonterra (China) Limited [Hong Kong]: A L Burton (R), J C Dale, M D Foster (R), G Hills, G M Cowan, J C Dale, M B N Dewdney, R M Kennerley (R), D B Learmonth, B T Willis (R) Kwok H Y (R), M J Newell, B P D Taylor (R) Fonterra Foods Pty Ltd [Australia]: 86 Fonterra (CIS) Closed Stock Company [Russia]: A M Coleman, D K Mallinson, G R Stuart | V Balabanov (R), A Erimen, G L Waterhouse, K A Wickham Fonterra Holdings (Mexico), S.A. de C.V. [Mexico]: Fonterra (Europe) GmbH [Germany]: L Barona Mariscal (A) , M D Foster (R), J R López Cortés (A), K A Wickham D A Matthews, J A Monroy Adame (A) (R), B T Willis, C J Wilson (R) Fonterra (Ing.) Limited [Mauritius]: J C Dale, M B N Dewdney, R M Kennerley (R), B P D Taylor (R) Fonterra Holdings (Thailand) Limited [Thailand]: 2005 ANNUAL REPORT M B N Dewdney (R), R M Kennerley (R), M J Newell, Fonterra (Italy) S.P.A. [Italy]: K Vunthanadit, C J Wilson P Pennati, G L Waterhouse, K A Wickham Fonterra Investments Pty Limited [Australia]: Fonterra (Japan) Limited [Japan]: A M Coleman, D K Mallinson, G R Stuart M B N Dewdney, H Fukaii, Y Fukuoka, N Furukawa (R), R M Kennerley (R), K Kumagai, T Morii, M J Newell, Fonterra Milk Australia Pty Ltd [Australia]: J P Shaskey G M Cowan, J C Dale, B M Ryan Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Subsidiary Company Directors (continued)

Inversiones Dairy Enterprises S.A. [Chile]: New Young Dairy Products Co., Ltd [Taiwan]: M P Campbell, R D Castro Urdiales (R), G M Cowan, T Launder (R), C C Lin, S Y Lin, K M Lin, Ng L S, J C Dale (A) (R), J C Dale, S Diez (A) , A J Duncan, J P Egaña L Pakiam (R), A R Sarker, M D Wynne (A), L O Herrera (A) , C Herrera (A) , L A J Kavanagh (A) (R), New Zealand Dairy Services (Latin America) Inc. [USA]: J L Letelier Azzari (R), S Obach (A) (R), S Obach (A), F Scott, R D Castro Urdiales G R Stuart (R), G Varela Alfonso (A) (R) New Zealand Milk (Australasia) Pty Ltd [Australia]: Key Ingredients, Inc. [USA]: G L Beatty, G M Cowan, D K Mallinson, D A Matthews, A L Burton (R), J C Dale, M D Foster (R), G Hills, J S Parker (R), G R Stuart (R) D B Learmonth, B T Willis (R) New Zealand Milk (Barbados) Ltd [Barbados]: La Pradera Milk Products, C.A. [Venezuela]: S A Eglinton, J C Pestana Soto R Chaw, O N de Massiani (A) , J L Iranzo, G R Stuart New Zealand Milk (Caribbean), Inc. [USA]: Mainland Dairies Pty. Ltd. [Australia]: R D Castro Urdiales G L Beatty, A M Coleman (R), G M Cowan, D K Mallinson, D A Matthews, G R Stuart (R) New Zealand Milk (Centram) S.A. [Panama]: R D Castro Urdiales, A D I De Raadt, J C Pestana Soto Mainland Foodservice Pty Limited [Australia]: G L Beatty, A M Coleman (R), G M Cowan, D K Mallinson, New Zealand Milk (CIS) Limited Liability Company D A Matthews, G R Stuart (R) [Russia]: H J Campbell (R), M K N Oldham Milk Products (New Zealand) Limited [Thailand]: J C Dale, A M Fitzsimmons, L Pakiam (R), A R Sarker, New Zealand Milk (Egypt) SAE [Egypt]: G R Stuart, M D Wynne M A A El-Tabei, G Glover, B Greaney, M Keats, J R Manikkam

Milk Products Holdings (Investments) Ltd [UK]: New Zealand Milk (Guatemala), S.A. [Guatemala]: G L Waterhouse J J Caceres, R D Castro Urdiales, A D I De Raadt (R), Z Looknanan-Clarke, J C Pestana Soto (R) Milk Products Holdings (Middle East) EC [Bahrain]: G M Cowan, G Glover, D K Knowlton, J R Manikkam, New Zealand Milk (Hong Kong) Limited [Hong Kong]: D A Pilkington (R) Ng L S, L Pakiam (R), A R Sarker, M D Wynne

Milk Products Holdings (North America) Inc. [USA]: New Zealand Milk (LATAM) Ltd [Bermuda]: J C Dale, M D Foster (R), G Hills, D B Learmonth, B T Willis (R) G M Cowan, J C Dale, C G Garrod, A L Smith (A), G R Stuart (R), N G Trollope Milk Products Holdings (SEA) Pte Ltd [Singapore]: D K Knowlton (R), L Pakiam (R), A R Sarker, M D Wynne New Zealand Milk (Malaysia) Sdn Bhd [Malaysia]: Chan T Y, G P Gomez Lackington, Lee W N, Ng L S (R), Milk Products Japan Ltd [Japan]: L Pakiam (R), A R Sarker, M D Wynne M B N Dewdney, T Inagaki, R M Kennerley (R), 87 P H Landon-Lane (R), M J Newell, J P Shaskey, B P D Taylor (R) New Zealand Milk (Mauritius) Ltd [Mauritius]: | P Ah Lim, G H Liu Man Hin, H M Liu Man Hin, L Pakiam (R), Murrumbidgee Dairy Products Pty Ltd [Australia]: A R Sarker, M D Wynne B S Donnison, P L Thorn New Zealand Milk (Singapore) Pte Ltd [Singapore]: N.Z. Milk Products (Thailand) Co., Ltd [Thailand]: D K Knowlton (R), L Pakiam (R), A R Sarker, M D Wynne A M Fitzsimmons, D M W Kennedy, L Pakiam (R),

S Prarusudamkerng, A R Sarker, K Vunthanadit (R), New Zealand Milk (Trading Singapore) Pte Ltd 2005 ANNUAL REPORT M D Wynne [Singapore]: D K Knowlton (R), L Pakiam (R), A R Sarker, M D Wynne New Tai Milk Products Co Ltd [Taiwan]: M B N Dewdney, R M Kennerley (R), Kwok H Y, New Zealand Milk (UAE) LLC [UAE]: P H Landon-Lane (R), C Lee, G Lee, M Lee, J Lee, M J Newell, E C Mulligan J P Shaskey, B P D Taylor (R) Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Subsidiary Company Directors (continued)

New Zealand Milk Enterprises (Russia) Limited Liability PT. Fonterra Indonesia [Indonesia]: Company [Russia]: G M Cowan, J C Dale, R M Kennerley (R), A J Kirby-Lewis (R), M S Harley (R), J Hines (R), D Kuznetsov (R), W R Leach (R), R A Suria, C J Wilson V Yarmalchouk (R), M K Oldham Recombined Dairy Systems A/S [Denmark]: New Zealand Milk Holdings (Mauritius) Limited K I McInteer, S A O'Keefe (R), G R Sharma, G L Waterhouse [Mauritius]: Saudi New Zealand Milk Products Company Limited J Jingree, S K Jogoo, L Pakiam (R), A R Sarker, M D Wynne [Saudi Arabia]: New Zealand Milk Lanka (Private) Ltd [Sri Lanka]: H Al Amout, A M H Al Marzoiki, G Glover, B Greaney, S M Abeyagunawardena (A) (R), S M Abeyagunawardena (A), J R Manikkam, P Thomsen, J Wood (R) A D I De Raadt, L Pakiam (R), A R Sarker, C Sri-Nammuni (A), Sociedad Agricola v Lechera Praderas Australes S.A. M D Wynne (“Pradesur”) [Chile]: New Zealand Milk Philippines, Incorporated A Alarcon Arava, H Covarrubius Lalanne, F Gana Eguiguren, [Philippines]: G P Gomez Lackington, J F Silva Barroilhet, M V Del Rosario, A M Fitzsimmons, D K Knowlton (R), J M Ugarte Undurraga, H Vega Medina R A Mendoza, C M Mendoza, L Pakiam (R), A R Sarker, Sociedad Procesadora de Leche Del Sur S.A. [Chile]: C Wee, M D Wynne E Alcalde Irarrázaval (R), J J Besa de Cárcer (R), M P Campbell, New Zealand Milk Products (Far East) Limited R D Castro Urdiales, A Cussen Mackenna, J C Dale (A), [Hong Kong]: S A Eglinton (R), L A J Kavanagh, D K Knowlton (A), D K Knowlton (R), L Pakiam (R), A R Sarker, M D Wynne J L Letelier Azzari, S D O'Connor (A), J C Pestana Soto (R), A Rey Recavarren (R), M Valdés Valdés (R), J R Valente Vias New Zealand Milk Products (UK) Ltd [UK]: (A), G Varela Alfonso (A) G R Sharma, G L Waterhouse Sociedad Productores de Leche S.A., Soprole [Chile]: Newdale Dairies (Pvt) Ltd [Sri Lanka]: E Alcalde Irarrázaval, E Alcalde Undurraga (A), S M Abeyagunawardena (A) , S M Abeyagunawardena (A) (R), J J Besa de Cárcer, M P Campbell, R D Castro Urdiales (A) (R), A D I De Raadt, L Pakiam (R), A R Sarker, C Sri-Nammuni (A), R D Castro Urdiales, J C Dale (A) , A J Duncan (A), M D Wynne S A Eglinton (R), L A J Kavanagh, D K Knowlton (A), NZMA Number Two Pty Limited [Australia]: J L Letelier Azzari, S D O'Connor (A) (R), S Oddo Gómez (A), G L Beatty, G M Cowan, D K Mallinson, D A Matthews, D A Pilkington (A) (R), W Riesco Salvo, G Varela Alfonso (A), G R Stuart (R) A Vergara del Río (A)

NZMP (AEM) Ltd [UK]: Solid Fresh Food & Beverage (M) Sdn. Bhd. [Malaysia]: K I McInteer, S A O'Keefe (R), G L Waterhouse Cheng K H (R), Lee S C, Lee S S, Ng L S (R), L Pakiam (R), A R Sarker, M D Wynne NZMP (UK) Ltd [UK]: 88

| G R Sharma, G L Waterhouse Solid Milk Industries Sdn. Bhd [Malaysia]: Cheng K H (A) (R), Lee S S (A) , Lee S C (A) , Ng L S (R), NZMP Venezuela S.A. [Venezuela]: L Pakiam (R), A R Sarker, M D Wynne M D Foster, M Perez Ortiz, B T Willis Susumas Sdn Bhd [Malaysia]: NZX Ltd [UK]: Chan T Y, G P Gomez Lackington, Lee W N, Ng L S (R), G L Waterhouse L Pakiam (R), A R Sarker, M D Wynne 2005 ANNUAL REPORT PB Foods Ltd [Australia]: TransContinental Distributors Ltd [Canada]: G L Beatty, D A Pilkington, N A Thomas B Kipping, D B Learmonth, D Tyers, B T Willis (R) Peters & Brownes Foods Limited [Australia]: Unilac Australia Pty Ltd [Australia]: G L Beatty, D A Pilkington, N A Thomas B S Donnison, P L Thorn Peters Foods (WA) Ltd [Australia]: United Milk Tasmania Limited [Australia]: G L Beatty, D A Pilkington, N A Thomas B S Donnison, P L Thorn PT New Zealand Milk Indonesia [Indonesia]: L Pakiam (R), D A Ross, A R Sarker Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Employee remuneration Fonterra’s frameworks and process for managing performance and remuneration have been steadily improved over the past year, following a major review of our global salaried remuneration framework. The review captured the views of management and staff and established a new remuneration framework, which better reflects Fonterra’s evolving business environment. The recommendations from the review will be fully implemented during the new financial year and has a focus on;

• Improving the links to Fonterra’s overall performance management framework; • Enhancing the management of remuneration to meet both external and internal compliance requirements, and; • Refreshing our incentive plans (see details below). As part of the review, Fonterra approved a new remuneration philosophy, with a focus on providing Fonterra’s managers with the clear accountability for managing the performance and the resulting reward and recognition of their employees, as well as the ability to differentiate reward and recognition based on performance. Fonterra also wished to provide its employee’s with the information required to know what is expected of them in Fonterra, and to manage their performance against this. Finally, given Fonterra’s geographical spread, a balance has been established between the requirements of the local markets (including the legal frameworks) and the need to create value by applying Fonterra’s frameworks in a consistent manner.

Base remuneration In the case of salaried staff, Fonterra operates a framework based on “total remuneration”. Fonterra pay’s both fixed and variable remuneration, which is consistent with the relevant local market, whilst rewarding exceptional performance. Fonterra also considers other factors in its framework, including internal equity to ensure the desired behaviours of Fonterra, flexibility and change are supported. Each year, remuneration surveys are conducted by independent remuneration consultants to measure Fonterra’s market position and advise on the setting of remuneration ranges and merit increase guidelines to maintain Fonterra’s market position consistent with the agreed policy.

Annual incentive plans Variable remuneration drive’s Fonterra’s performance by;

• Aligning the objectives of the company to ensure collaboration and the one team approach to achieve Fonterra’s goals. • The establishment of targets which are stretch yet achievable, and; • Linking the levels of reward to the performance of the company, teams, and individuals. Our incentive programs act as an important communication device, signalling to employees what is most important to Fonterra and how success in Fonterra is measured and rewarded. At the commencement of each operating year, a series of Key Performance Indicators (KPIs) are identified and agreed. These KPIs are a series of financial and operational measures drawn from the three-year strategic plan and the annual operating budget. The actual KPIs used in the annual incentive plan include (but are not limited to):

Net Profit after Tax, Milk Payout, Economic Profit, Organic Growth, Working Capital Efficiency, New Product Development, 89

People Development. | 2005 ANNUAL REPORT Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Employee remuneration (continued) For each KPI, a range of performances for payment purposes is determined, with the range defined by:

• Threshold – performance less than the threshold results in no payment; • Target – performance to the targeted level results in an ‘On Target’ payment; • Maximum – performance to/beyond this level will result in a maximum available payment. In addition to the above business measures, Fonterra’s new remuneration framework will now take into account an element of individual performance. A link with our performance management system “PERFORM” and the short-term incentive plan has been developed. This link is intended to drive the right level of individual focus whilst ensuring the overall business targets are met. The primary driver of any resulting payment is therefore the business results. At the end of each operating year, performance against the KPIs is determined and independently reviewed. Any payments made in the Short Term Incentive (STI) Plan are adopted and approved by the Appointments Renumeration and Development Committee.

Long term incentive For certain key executives, Fonterra operates a Long Term Incentive (LTI) Plan. This plan is designed to motivate, reward and retain key executives. This plan was fully revised during the Salaried Remuneration Framework Review. The plan now has the following features:

• The new plan compares Fonterra’s Total Shareholder Return (“TSR”) with that of 24 other external “comparator” companies, over a three-year period. The comparator companies are selected based on geographical spread, food and beverage companies, and, ingredients and consumer companies; • No amount is earned if Fonterra’s ranking is less than the 50th percentile of the comparator group; • Once payments have vested (after a minimum of 3-years), participants have the option to exercise or defer a percentage of the amount earned; • A new 3-year cycle commences each year. Any payments made in the LTI Plan are adopted and approved by the Appointments Remuneration and Development Committee. The LTI for the Chief Executive Officer is adopted and approved by the Board.

90 | 2005 ANNUAL REPORT Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Employee remuneration (continued) Employee Remuneration analysis – Amounts paid for the financial year ended 31 May 2005

Year ended 31 May 2005

Remuneration Range NZ1 Offshore2 Cessations3 Total

100,000 110,000 143 60 13 216 110,001 120,000 101 45 16 162 120,001 130,000 79 51 21 151 130,001 140,000 53 39 16 108 140,001 150,000 39 27 9 75 150,001 160,000 36 23 7 66 160,001 170,000 22 22 9 53 170,001 180,000 22 19 2 43 180,001 190,000 11 20 3 34 190,001 200,000 9 16 3 28 200,001 210,000 8 11 4 23 210,001 220,000 12 10 3 25 220,001 230,000 12 8 3 23 230,001 240,000 8 9 3 20 240,001 250,000 9 13 1 23 250,001 260,000 5 4 1 10 260,001 270,000 2 8 1 11 270,001 280,000 6 6 2 14 280,001 290,000 5 4 1 10 290,001 300,000 4 3 1 8 300,001 310,000 2 8 0 10 310,001 320,000 2 3 1 6 320,001 330,000 2 7 1 10 330,001 340,000 0 3 0 3 340,001 350,000 4 7 0 11 350,001 360,000 2 3 0 5

360,001 370,000 1 5 1 7 91

370,001 380,000 0 3 0 3 | 380,001 390,000 2 3 0 5 390,001 400,000 1 0 0 1 400,001 410,000 0 2 0 2 410,001 420,000 1 7 1 9

420,001 430,000 0 1 1 2 2005 ANNUAL REPORT 430,001 440,000 1 0 0 1 440,001 450,000 2 3 0 5 450,001 460,000 3 2 1 6 460,001 470,000 0 1 0 1 470,001 480,000 0 1 0 1 480,001 490,000 1 0 0 1 490,001 500,000 1 2 0 3 510,001 520,000 0 0 1 1 Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Employee remuneration (continued) Employee Remuneration analysis – Amounts paid for the financial year ended 31 May 2005

Remuneration Range Year ended 31 May 2005

NZ1 Offshore2 Cessations3 Total

520,001 530,000 0 2 0 2 530,001 540,000 2 1 0 3 540,001 550,000 1 0 0 1 550,001 560,000 1 2 0 3 560,001 570,000 2 2 1 5 590,001 600,000 0 1 0 1 600,001 610,000 0 1 0 1 630,001 640,000 0 1 0 1 640,001 650,000 2 0 0 2 670,001 680,000 0 1 0 1 690,001 700,000 0 1 0 1 710,001 720,000 3 0 0 3 720,001 730,000 0 0 1 1 740,001 750,000 0 1 0 1 750,001 760,000 0 0 1 1 780,001 790,000 1 0 0 1 790,001 800,000 0 2 0 2 800,001 810,000 1 0 0 1 820,001 830,000 1 0 0 1 830,001 840,000 0 2 1 3 860,001 870,000 0 1 0 1 870,001 880,000 0 1 0 1 900,001 910,000 1 1 0 2 930,001 940,000 0 1 0 1 960,001 970,000 0 1 0 1 1,020,001 1,030,000 0 0 1 1 1,220,001 1,230,000 1 0 0 1 92

| 1,360,001 1,370,000 1 0 0 1 1,430,001 1,440,000 1 0 0 1 1,520,001 1,530,000 0 0 1 1 2,580,001 2,590,000 1 0 0 1 3,320,001 3,330,000 0 0 1 1 Total 630 481 133 1,244 2005 ANNUAL REPORT

NOTES 1 Includes employees employed in New Zealand solely during the current financial year. 2 Includes employees that were employed in an overseas operation during the current financial year. Amounts paid in foreign currency have been translated at an average conversion rate for the financial year. 3 Cessations include employees that have been terminated or retired during the financial year. The amounts paid to former employees include salary and bonuses for the current year, prior year bonuses that have been paid in the current year (which were accrued at 31 May 2004) and termination entitlements including those arising from employment arrangements entered into by legacy companies prior to the formation of Fonterra. Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

Current credit rating status Standard and Poor’s Rating Services and Fitch Ratings have rated the Company AA- with a rating outlook of stable. Capital Notes which are subordinate to other Fonterra debt issued are rated A+ by Standard and Poor’s.

Exchange rulings and waivers The New Zealand Exchange Limited (“NZX”) has ruled that the Capital Notes do not constitute “equity securities” under its Listing Rules. This means that where Capital Notes are quoted on NZX, the Company is not required to comply with certain Rules which apply to an issuer of quoted equity securities. NZX has also determined that a “Minimum Holding” for Fonterra Capital Notes is Capital Notes having a face value of $5,000 (rather than the $1,000 as currently provided for in Appendix 2 of the Listing Rules). NZX exercised its powers under Rule 5.4.2(b) on 12 July 2004, pending release of information that day relating to the Capital Note interest rate calculation. There are no waivers in effect at Balance Date.

Entries in the interests register (A) Directors’ Interests in Transactions (1) General Disclosures of Interest The following general disclosures of interest were made during the year: G R W France Cessation of Directorship of Zazu Limited; Cessation of membership of the Market Surveillance Panel, New Zealand Stock Exchange; Director of Liggins Institute. J W van der Poel Cessation of interest in Patetonga Farm Ltd, Chairman of Dexcel Ltd. E S Rattray Trustee of Camus Farm Trust. G S Hawkins Chairman of Liggins Institute; Director and shareholder of Biomed Holdings Limited. G W Gent Director of Farmers’ Mutual Insurance Group (“FMG”). M G Townshend Mr Townshend advised he was participating in the purchase of farmland in Chile, and related dairy interests. This was subsequently disclosed as directorships of Kauri SA, Rimu SA, Manuka SA and Trebol Investments Ltd. Cessation of interest in Kapiti Cheeses Ltd. H W van der Heyden Director and shareholder of Maglands Limited; Director and shareholder of Tawin Lands Limited; Shareholder of Tasman Farms Pty Ltd. M G Bailey Director and shareholder of Embryo Technologies Limited; Director and shareholder of Bailey Agriculture Limited; Director of Process Solutions Group Limited. D M Hoare Cessation of consultancy to Mallesons Stephen Jacques; Cessation as Chairman of the Australian Graduate School of Management; Pro Chancellor of Senate of the University of Sydney. H G Bayliss Director and shareholder of Bayliss Holdings Limited; Cessation of advisory role to ViaLactia 93

Biosciences (NZ) Limited; Cessation of directorship of Bonlac Foods Limited. | J S Wilson Director of South Auckland Independent Testing Society Limited. S J Nattrass Shareholder of Cropmark Seeds Ltd, Cedric Holdings Ltd and Estaronline Ltd.

(2) Specific Disclosures Nil 2005 ANNUAL REPORT Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

(B) Securities dealings of directors The following entries were made in the Interests Register during the year. (1) New disclosures Directors disclosed the following holdings of Co-operative Shares during the year:

Co-operative Shares

Held by Associated Persons

Earl Rattray 71,755 Stuart Nattrass 1,084,461 John Wilson 151,445 Malcolm Bailey 93,685

(2) End of Season Changes Directors disclosed the following transactions associated with end of season adjustments.

Held by Associated Persons Jointly held with Associated Persons

03 04 03 04

Jim van der Poel 362,313 82,684 2,062 16,891 Jim van der Poel (SRR conversion) 0 43,339 8,104 745 Jim van der Poel (103,823) 0 n.a. n.a. Jim van der Poel (SRR conversion) (48,108) (61,615) (25,560) n.a. Earl Rattray (SRR conversion) n.a. n.a. 10,924 2,699 Stuart Nattrass 4,575 179,146 n.a. n.a. Stuart Natrass (SRR conversion) 99,251 7,497 n.a. n.a. Greg Gent (SRR conversion) (13,459) n.a. Mark Townshend 2,245 28,651 n.a. n.a. Mark Townshend (SRR conversion) (25,204) 66,845 n.a. n.a. Mark Townshend 0 (27,278) n.a. n.a. Mark Townshend (SRR conversion) (121,877) 0 n.a. n.a. Henry van der Heyden 5,486 4,322 Henry van der Heyden (SRR conversion) 4,507 0 94

| Malcom Bailey (SRR conversion) 0 14,200 n.a. n.a. Harry Bayliss 15,131 9,495 Harry Bayliss (SRR conversion) 0 8,376 Harry Bayliss ($4.69) (34,385) 0 John Wilson 0 0 192,528 100,425 John Wilson (SRR conversion) (8,343) 9,000 68,836 0 2005 ANNUAL REPORT

In the cases identified as “03”, the allocations or surrenders relate to the 2002/03 end of season changes and were made on 8 July 2003 in accordance with the Constitution. The value upon allocation of these securities was $3.85 per co-operative share. Where indicated above, conversions to or from SRRs were at a value of $3.85. Surrenders were made at a value of $4.25 per co-operative share. In all other cases, the allocations or surrenders relate to the 2003/04 end of season changes and were made on 5 July 2004 (or such other date as indicated) in accordance with the Constitution. The value upon allocation of these securities was $4.38 per co-operative share. Where indicated above, conversions to or from SRRs were at a value of $4.38. Surrenders were made at the $4.38 unless otherwise specified. Statutory Information For the year ended 31 May 2005 Fonterra Co-operative Group Limited

(3) Other Trading Activities J W van der Poel: Mr van der Poel ceased to have a relevant interest in 222,743 Co-operative Shares, held by persons who had been Associated Persons. On 5 July 2004, Associated Persons of Mr van der Poel transferred 240,389 Co-operative Shares to other shareholders. S J Nattrass On 8 July 2003, Associated Persons of Mr Nattrass transferred 83,918 Co-operative Shares to other shareholders. On 5 July 2004, Associated Persons of Mr Nattrass transferred 33,093 Co-operative Shares to other shareholders. G W Gent Mr Gent advised he had contracted to purchase 79,318 Co-operative Shares as at 1 June 2005 as part of a farm purchase. H G Bayliss Mr Bayliss advised Associated Persons had contracted to purchase 189,600 Co-operative Shares as at 1 June 2005 as part of a farm purchase. J S Wilson Mr Wilson advised he had contracted to purchase jointly with Associated Persons 772,798 Co-operative Shares as at 1 June 2005 as part of farm purchases. (C) Loans to directors There have been no loans to Directors. (D) Directors’ remuneration The Directors’ Remuneration Committee, comprising six shareholders appointed under the constitution, makes recommendations for shareholder approval as to the level of Directors’ fees. At the Annual Meeting of Shareholders held on 7 October 2004, shareholders approved, on the recommendation of the Directors’ Remuneration Committee, the following amounts of remuneration effective until the next Annual Meeting of Shareholders.

Chairman $205,000 p.a. Directors $100,000 p.a. Additional payment to the Chairman of the Audit Finance & Risk Committee (except if the Chairman is the Fonterra Chairman) $10,000 p.a.

The Board has a policy of applying the same remuneration levels to directors appointed under clause 12.4 of the Constitution. The Directors’ Remuneration Committee, at the request of the Board, considered and supported the payment of an allowance of $10,000 p.a. to the Chairman of the Fair Value Share Review Committee. The Board exercised its discretion to make this payment, under clause 34 of the Constitution, since an appointed director is the Chairman of the Fair Value Share Review Committee. 95

In general, fees paid by subsidiary or associate companies in respect of Fonterra directors or employees serving as directors of | those companies are payable directly to Fonterra. The Company made payment to Mr Bayliss of the previously approved and disclosed allowance of $3,750 per month, in respect of the period from October 2003 to September 2004 inclusive, in recognition of his service as a director of Bonlac Foods Limited. (E) Directors’ indemnity and insurance 2005 ANNUAL REPORT Fonterra has given indemnities to, and has effected insurance for, Directors and executives of the company and its related companies, in accordance with section 162 of the Companies Act 1993, and Fonterra’s Constitution, which, except for specific matters that are expressly excluded, indemnify and insure Directors and executives against monetary losses as a result of actions undertaken by them in the course of their duties. Among the matters specifically excluded are penalties and fines that may be imposed for breaches of law. Separate Deeds of Indemnity have been entered into between the Company and its appointees to the Bonlac Foods Limited board and the boards of its Chilean subsidiaries, in respect of their roles as directors of those companies. Contacts

Fonterra Corporate Centre Fonterra Group Manufacturing Private Bag 92032 P O Box 459 Auckland Hamilton NEW ZEALAND NEW ZEALAND 64 9 374 9000 (phone) 64 7 839 8398 64 9 379 8284 (fax) 64 7 839 8118

Wellington Office Fonterra Innovation PO Box 417 Private Bag 11029 Wellington Palmerston North 5320 NEW ZEALAND NEW ZEALAND 64 4 471 8999 (phone) 64 6 350 4649 (phone) 64 4 471 8600 (fax) 64 6 356 1476 (fax)

Fonterra Ingredients Fonterra Milk Supply Private Bag 92032 Private Bag 92032 Auckland Auckland NEW ZEALAND NEW ZEALAND 64 9 374 9000 (phone) 64 9 374 9000 (phone) 64 9 379 8284 (fax) 64 9 379 8284 (fax)

Fonterra Brands Fonterra Milk Supply Private Bag 92032 Contact Centre Auckland 0800 65 65 68 NEW ZEALAND Fencepost 64 9 374 9000 (phone) P O Box 37735 64 9 379 8284 (fax) Parnell Fonterra Specialty Products NEW ZEALAND Private Bag 92032 64 9 336 0250 (phone) Auckland 64 9 336 0274 (fax) NEW ZEALAND RD1 64 9 374 9000 (phone) P O Box 9045 96 64 9 379 8284 (fax)

| Hamilton Fonterra Foodservices NEW ZEALAND 830 Wellington Road 64 7 858 0600 (phone) Rowville VIC 3178 64 7 858 0601 (fax) AUSTRALIA www.fonterra.com

2005 ANNUAL REPORT 61 3 9764 6677 (phone) 61 3 9764 5356 (fax) PATHS TOLEADINDAIRY

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